Banks Stress Test Wells Fargo
Paul Sakuma  /  AP
A Wells Fargo Bank in Palo Alto, Calif. Regulators are asking Wells Fargo & Co. to raise more capital after government "stress tests" showed the bank would have trouble surviving if the recession worsens.
updated 5/5/2009 9:26:02 AM ET 2009-05-05T13:26:02

Banks will be told Tuesday how they did on their "stress tests" and informed of regulators' final decisions on how much capital they need to raise.

Officials will announce publicly on Thursday how the 19 largest banks fared on tests of how much they would lose if the recession unexpectedly worsened. If the test found a bank's reserves would fall below a minimum level, that bank would have to raise more capital beyond what's now required.

As regulators prepare to reveal how banks fared on "stress tests" — a key part of the government's plan to fix the financial system — investors seem ready to take the news in stride. A handful of banks will likely be told to raise capital, though none will be allowed to fail.

But analysts said the industry still faces serious problems — including bad assets that are making it hard for banks to resume normal lending.

One way for banks to boost capital is to convert the government's existing stake in them from preferred shares — a form of debt — into common stock. But that would dilute the value of common shares and put taxpayer dollars at more risk.

Banks also could be given six months to raise money from investors. If that didn't work, the government could give them more money from the $700 billion bailout fund.

For weeks, speculation about their results worried investors and analysts. Many feared that negative findings about some banks would cause investors to sell off their stocks and destabilize the markets.

Until banks can return to normal lending, it will be hard for businesses to expand or survive a downturn. Consumers need loans to make the purchases that could revive the economy.

The markets appear soothed by official statements that the banking system is strong. Regulators have said no large institution will be allowed to fail.

Despite an Associated Press report Monday that regulators might make Wells Fargo & Co. bolster its finances, the company's stock price leapt more than 23 percent. Other banks that have been the subject of such speculation — including Cleveland-based KeyCorp and Cincinnati-based Fifth Third Bancorp — posted similar gains as the financial sector led a 214-point rally in the Dow Jones industrial average.

"Obviously, the market is not worried about (the stress tests) right now," said Robert Pavlik, chief market strategist at Banyan Partners LLC. "This is going to be seen as a giant non-event."

Major Market Indices

The government's statements have reassured investors, he said, noting that banks that need more capital will have six months to raise it. That's "plenty of time," Pavlik said.

The results will show only "modest shortfalls" for most of the 19 banks, Fox-Pitt Kelton analyst David Trone said in a research note.

But critics warned that the tests have diverted attention from a more fundamental problem: bank assets that have lost value and can't be sold.

Those assets, backed by pools of loans for construction, home mortgages and other debt, were the target of then-Treasury Secretary Henry Paulson's original bank rescue plan. When Secretary Timothy Geithner rolled out his financial stability plan in February, he proposed to buy up the same bad assets, using a combination of private funds and $100 billion from Treasury's financial bailout fund.

Because those assets lost value as loan defaults rose, investors aren't willing to pay much for them. Banks refuse to sell the assets at steep discounts. Yet as long as they remain on balance sheets, there's less money for lending.

Treasury's plan to attract private investors to buy up the banks' bad assets would leave banks with "cleaner and stronger" balance sheets, Geithner has said. But so far, the plan seems stuck in neutral. Treasury has yet to spell out exactly how it will work. And large banks, including JPMorgan Chase, have balked at participating, partly out of concern that the government will restrict executive pay.

Simon Johnson, a former International Monetary Fund chief economist now at the Massachusetts Institute of Technology's Sloan School of Business, said he doesn't know anyone in the financial world planning to participate.

In part, he said, it's "because of the potential oversight," and "banks feel no pressure to sell" because they expect the government to keep supporting them.

Meanwhile, news reports have leaked about how various banks performed on their stress tests.

Wells Fargo is one of several that regulators said would need more capital to protect against possible future losses, according to two people familiar with the matter who spoke on condition of anonymity because of the sensitivity of the process.

The initial results were given to the banks last month. Wells Fargo has until Tuesday to convince officials the results were mistaken and that it doesn't need more capital. Wells Fargo spokeswoman Julia Tunis Bernard declined to comment.

Thursday's announcement will be made by Geithner and Federal Reserve Chairman Ben Bernanke. The government will release more than 100 pages of information, according to a person briefed on the plans who requested anonymity because he wasn't allowed to discuss it publicly.

Wells Fargo holds billions of dollars in mortgage, construction and credit card loans. The stress tests treated those loans as vulnerable because borrowers would have trouble repaying their debts if the recession worsened.

Analysts expect some regional banks will need to raise capital, since their holdings are similarly tilted toward loans. KeyCorp and Fifth Third Bancorp are among them.

Bank of America Corp. and Citigroup Inc. have been disputing preliminary findings that they needed to boost capital, sources have told the AP.

Spokesmen for New York-based Citigroup and Charlotte, N.C.-based Bank of America wouldn't comment on whether they'd been asked to raise more capital.

But Bank of America spokesman Scott Silvestri called a news report that it plans to raise $10 billion "completely inaccurate." Bank of America hasn't been given a final figure from the Fed, he said.

Andrew Marquardt, a bank analyst at Fox-Pitt Kelton, said Wells Fargo's capital risk is fairly minimal.

"If indeed they need additional capital, it's going to be a fairly modest amount," he said.

Copyright 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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