Stress test day arrives at last

NEW YORK (CNNMoney.com) – At long last, investors will get some much-needed answers about whether the nation’s biggest banks need more capital – and how much.
For weeks, Wall Street has been waiting with bated breath on the outcome of the so-called „stress tests“ regulators have been conducting on the nation’s 19 largest banks, institutions with more than $100 billion in assets as of the end of last year.
But the results, which are due out after Thursday’s market close, may not offer any stunning revelations.
In recent days, there has been a flurry of leaks regarding the results of the tests.
Reports surfaced late Tuesday that Bank of America (BAC, Fortune 500) may need roughly $34 billion in capital to weather a more painful economic environment.
Rivals of the Charlotte-based lender, including Wells Fargo (WFC, Fortune 500) and Citigroup (C, Fortune 500), have also been frequently mentioned in recent days as two institutions in need of capital.
Other banks that are believed to be in tip-top shape, namely Goldman Sachs (GS, Fortune 500) and JPMorgan Chase (JPM, Fortune 500), have been increasingly cited as companies that probably won’t be required to raise capital.
And in a report earlier this week, David Hendler, an analyst with CreditSights, told clients that he thought Morgan Stanley (MS, Fortune 500) and Bank of New York Mellon also probably do not need more capital.
Still, analysts say there are a lot of questions that remain unanswered, including the health of regional banks that were tested such as Fifth Third Bancorp, PNC and Regions Financial.
It is also unclear how the more unique financial institutions of the group, such as insurer MetLife (MET, Fortune 500) and auto finance firm GMAC, fared in the stress tests.
Regulators were originally expected to publish the results earlier this week, but Obama administration officials and other top regulators have indicated that the release was postponed amid disagreement by banks over the findings of the tests.
„It’s a very complicated process, a very extensive and detailed exercise. We took the information back to banks, not to negotiate, but to work out communication problems,“ Federal Reserve Chairman Ben Bernanke said Tuesday during a hearing of the Joint Economic Committee of Congress.
After the stress subsides
When the White House launched the program in late February, officials maintained that it was designed largely to help identify which banks may require additional government support.
Hoping to put a finer point on that, regulators, including the Office of Thrift Supervision and the Federal Deposit Insurance Corporation, considered the performance of a wide variety of assets owned by banks under current economic expectations and a more „adverse“ scenario over the next two years.
But there have been concerns by some that regulators may have erred on the side of optimism.
„That’s the big question,“ said Stuart Plesser, an equity research analyst for Standard & Poor’s. „Is it going to be severe enough?“
For example, one assumption under the more severe case was that the nation’s unemployment rate would climb to 10.3% sometime in 2010. The unemployment rate hit 8.5% in March and economists are predicting it hit 8.9% in April.
After releasing the methodology of stress tests two weeks ago, senior officials pointed out they were trying to rely on plausible economic forecasts, without being too severe on banks.

In a statement Wednesday, the Federal Reserve, Treasury, FDIC and Office of the Comptroller of the Currency confirmed that banks that need to shore up their financial position will have 30 days to present their capital-raising strategy to regulators and six months to carry it out. If those efforts fail, then the government would step in to provide the necessary funds.
Regulators also indicated that during the month when banks are planning their strategy to raise capital, they will also „need to review their existing management and Board in order to assure that the leadership of the firm has sufficient expertise and ability to manage the risks presented by the current economic environment.“
That statement appears to indicate that the government is going to take a tougher stance with executives at struggling banks, as it did with General Motors. Former GM CEO Rick Wagoner stepped down in late March after the Obama administration deemed that the company did not have a long-term plan for viability.
Many bank CEOs, most notably Ken Lewis of Bank of America, have come under fire from shareholders during the banking crisis. Lewis was forced to step down as chairman of BofA last week following a shareholder vote at the company’s annual meeting.
Top regulators, including FDIC Chairman Sheila Bair, are already pushing capital-strapped banks to try and raise capital on their own. That could come through issuing stock or from an asset sale.
Barring that, banks may have to convert some of the government’s preferred share stake as a result of last fall’s bank bailout into common stock to help boost their capital levels. Citigroup already announced such a plan in late February.
Such moves would boost a bank’s closely watched tangible common equity ratio, one measure of financial strength. Investors have tended to endorse the view that banks with a TCE below 3% are not adequately positioned to absorb big losses.
Regulators may push banks to consider converting preferred shares to common stock since that would not require the government to kick in any new taxpayer funding beyond the money already invested in them through the Treasury’s Troubled Asset Relief Program, or TARP.
But banks would risk diluting existing shareholders by doing so. And that could result in a hit to their stock prices. However, bank stocks have surged in the past two months despite concerns about the stress tests.
So if Thursday’s results don’t spook investors, some analysts suspect that financial institutions may want to consider raising capital on their own – something that most banks have not been able to do until recently.