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Bringing Confidence Back to Banks – 10 Banks Told to Raise $75 Billion to Ensure Survival

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By Kevin G. Hall

RISMEDIA, May 11, 2009-(MCT)-Federal regulators released the final results of their bank stress tests and ordered 10 of the nation’s 19 largest banks to raise a total $75 billion in new capital to ensure their survival should the economic downturn worsen.

The tests on the companies, which together represent two-thirds of the banking sector and each with assets of more than $100 billion, measured how their loans and investments might perform if the economy took a much more serious turn for the worse. The tests projected that the banks would suffer up to $600 billion in new losses through 2010 under the most adverse conditions.

Based on this information, regulators decided which banks needed to raise more capital for worse conditions. Those companies, and the amounts they must raise, are as follows:

-Bank of America $33.9 billion
-Wells Fargo $13.7 billion
-GMAC $11.5 billion
-Citigroup $5.5 billion
-Regions Financial $2.5 billion
-SunTrust Banks $2.2 billion
-KeyCorp $1.8 billion
-Morgan Stanley $1.8 billion
-Fifth Third Bancorp $1.1 billion
-PNC Financial Services $600 million

Companies in the clear, freed from having to raise more capital, include Goldman Sachs, Bank of New York Mellon, J.P. Morgan Chase, BB&T, State Street, U.S. Bancorp, insurer MetLife, and credit card companies American Express and Capital One Financial.

“The results should provide considerable comfort to investors and the public,” Federal Reserve Chairman Ben Bernanke said.

“We hope banks are going to go back to the business of banking,” Treasury Secretary Timothy Geithner said.

Banks deemed to need more capital can sell more stock, seek equity partners, sell assets such as their stakes in foreign banks or nonessential businesses, and convert preferred shares of stock into common stock. Absent all else they can convert taxpayer bailout money into shares of stock owned by the federal government.

Shortly before the results were made public, Wells Fargo announced that it would seek $6 billion in new stock to work toward its newly ordered buffer. And Morgan Stanley said it would seek to raise $2 billion in a stock offering and later raise another $3 billion in senior debt notes.

For consumers, the results could mean it will be even harder to borrow during the next 18 months. Banks must boost their balance sheets, and in the short run that generally means less lending to consumers and businesses.

“We expect for some time demand from consumers to be weak,” Bernanke said, adding that regulators don’t “want the banks to be making bad loans.”

Over a longer period, however, regulators think that banks will be better positioned to lend when the economy recovers.

For regulators, results point to a glass half full. The fact that the 19 banks must raise only a combined $75 billion as a buffer against potentially greater losses suggests that they’re relatively well capitalized.

Critical analysts, however, see a glass half empty in the stress-test results.

“It’s a very educated guess, based on a lot of information, but they can’t see the future,” said Douglas Elliott, a financial analyst at the Brookings Institution, a center-left research center. “If they were off by just 3 percent in 2010, that’s $300 billion in additional capital (needed). I give them a lot of credit and it’s a useful exercise, but prediction is extremely difficult.”

Elliott projected capital needs from $100 billion to $200 billion, and wonders how accurate the regulators’ projections are for losses that are expected on commercial and industrial loans and defaults on commercial mortgages.

“At least with residential (mortgages) the bad things that have happened are already in the numbers. These loans to businesses, we’re just starting to see them, so there is a fair amount of uncertainty,” he said.

Offering a grimmer projection, the International Monetary Fund in its April Global Financial Stability Report said that U.S. banks needed $275 billion in additional capital as of the end of 2008 and projected that $2.7 trillion in write-downs on U.S.-originated assets will be needed through the end of 2010. Under worse scenarios, the IMF said, losses could top $4 trillion, two-thirds of them borne by global banks.

The stress tests are as much about politics as they are about economics. They bought the Treasury Department roughly three months to put off tough political decisions such as how to conduct the auction of toxic assets through a public-private partnership now expected to begin in June.

During the past three months, economic indicators have begun to show the first signs of a possible turnaround, relieving some of the worry about the banks. The stress tests worse-conditions scenario envisioned a 3.3% economic contraction this year, followed by no growth next year and unemployment peaking at 10.3%.

The stress-test exercise also deflected attention from the problem that hasn’t gone away: how to value the trillions in toxic assets that are polluting bank balance sheets.

“They’ve got no reason to make significant losses going forward, but it doesn’t tell you the losses that could be incurred (by banks) when they recognize their previous mistakes,” said Vincent Reinhart, a former top economist on the Fed’s rate-setting Open Market Committee.

In other words, the results signal a profitable future but paper over the present. “In that sense, they are doing it in part to build confidence, because if markets are more confident about banks, markets and the economy will do better. And if markets and the economy do better, banks do better,” said Reinhart, now a scholar at the American Enterprise Institute, a conservative think tank.

The tests, he added, are “designed to build up market confidence and create the most favorable response as possible. I think they are trying to manage the media.”

(c) 2009, McClatchy-Tribune Information Services.

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