Stress Test Indicates That About 10 Banks Will Need Additional Capital

More is being leaked about the stress tests. Now it appears that 10 of the 19 banks subjected to the stress test will need additional capital. The final results are due out Thursday so we will be able to see for ourselves at that time. Text in bold is my emphasis. From the WSJ:

The U.S. is expected to direct about 10 of the 19 banks undergoing government stress tests to boost their capital, according to several people familiar with the matter, a move that officials hope will quell fears about the solvency of the financial sector.

The exact number of banks affected remains under discussion. It could include Wells Fargo & Co. (after swallowing Wachovia I am not surprised they need more capital), Bank of America, Citigroup Inc. and several regional banks. At one point, officials believed as many as 14 banks would need to raise more funds to create a stronger buffer against future losses, these people said, but that number has fallen in recent days.

Representatives from Wells, Bank of America and Citi declined to comment.

The Obama administration announced the stress tests -- a process of examining banks' ability to withstand future losses -- back in February. At the time, the news sparked concern among investors and depositors that the results would be used to shut down or nationalize some of the country's weaker institutions. But Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner assured investors that none of the banks undergoing stress tests would be allowed to fail and that all would have access to government funds if needed.

In fact, the stress-test regimen appears so far to have eased some of the fears that swept through financial markets in February, just as President Franklin D. Roosevelt's bank holiday did in 1933. He shut down the nation's banks for several days during a banking panic and only reopened those the government deemed safe. One possible explanation for the recent, calmer state of affairs: The problems the tests appear to be uncovering aren't as bad as some analysts' worst expectations.

Also, if multiple banks are being directed to boost their capital, that could make the process seem less daunting than if it were singling out a few companies as weak.

In a sign of how much the doomsday scenario has faded, bank stocks surged Monday despite reports that Wells Fargo was identified in an initial review as one of the financial institutions needing a stronger buffer.

The San Francisco bank's stock jumped 24%, or $4.64, to $24.25 in New York Stock Exchange composite trading at 4 p.m. Bank of America shares rose 19% on Monday, while Citigroup was up 7.7%.

The stock prices of all three banks, which may need to raise tens of billions in new capital as a result of the stress tests, have tripled since early March.

It's possible Wall Street is being overly optimistic about the impact of the results and the resulting dash by banks to bolster capital. One big risk worrying industry officials is that the market will view banks on the list as insolvent when the official results are announced Thursday, even though Fed officials have repeatedly said that's not the case.

Several banks are expected to already have enough capital to weather a worsening economy, including Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. J.P. Morgan Chase Chairman and Chief Executive James Dimon expressed confidence Monday that the banking system can withstand losses from the recession, even though it will take years for the industry to recover.

"The banking system can handle an awful lot of stress and be OK," he said in a Monday conference call sponsored by Calyon Securities Inc., a unit of Credit Agricole Group.

Mr. Dimon also reiterated J.P. Morgan's goal to repay the $25 billion the New York bank received from the government last year "as soon as possible," saying company officials plan to discuss details of the potential repayment after the stress-test results are announced.

An initial stress test identified Wells Fargo as among the banks needing a bigger buffer, said a person close to the company. It is unclear whether Wells would be forced to raise fresh capital or if regulators would accept the bank's argument that it can earn its way through the losses in future years. Wells expects more clarity Tuesday.

Any bank holding company with more than $100 billion in assets was required to undergo the tests, which were largely conducted by the Fed. Their purpose was to ensure that major financial institutions had enough capital to continue lending if the economy worsened through 2010. Government officials are expected to meet with banks beginning Tuesday to go over final results. Banks directed to raise more capital aren't necessarily in trouble today, but regulators think they don't have enough of a buffer against potential future losses.

Administration officials believe many banks will be able to raise capital without tapping the Troubled Asset Relief Program's remaining $109.6 billion. They're optimistic the bulk of the money will come from private investors made more confident by the glut of information provided by the tests. Banks could sell assets and stakes in their companies, a move that could accomplish another government goal of shrinking some of the country's largest banks.

Officials say banks that can't tap private markets will be able to raise capital by agreeing to convert some of the government's existing preferred shares into common equity, a move that would leave the government owning chunks of the nation's largest banks.

"There undoubtedly will be banks that need more capital," White House spokesman Robert Gibbs said Monday in a news briefing. He said he didn't believe the Obama administration would need to ask Congress for more money. "I think everyone involved will be looking for banks to raise this through either private means or the selling of some assets that they have or that they control."

The tests have set off some tense exchanges in private between Treasury officials and bank regulators at the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, who worried that disclosing too much information publicly could threaten the health of banks that are trying to repair themselves.

The Fed plans to release the results of the stress tests on Thursday after U.S. stock markets close. Anticipating the test results, McGraw-Hill Cos.' Standard & Poor's Ratings Service unit put on watch for downgrade the credit ratings of 22 banks and one thrift.

The affected companies face at least a 50% chance of being downgraded by at least one notch in the next 90 days.