Bank Stress Tests Turn Up 10 Banks That Need More Capital

By Jason Simpkins
Managing Editor
Money Morning

The U.S. Federal Reserve today (Tuesday) delivered the results of its bank stress tests to the 19 participating financial institutions. The government will tell 10 of the banks to raise more capital, according to media reports. 

The results of the tests won't be released until Thursday, but Bank of America Corp. (NYSE: BAC), Citigroup Inc. (NYSE: C), and Wells Fargo & Co. (NYSE: WFC) are among the institutions expected to be facing capital shortfalls.

Money Morning last month reported that Bank of America and Citigroup were told by federal regulators to raise more capital after the government's stress tests revealed that the banks were not adequately protected against additional deterioration in the economy.

The number of institutions requiring more capital rose from six to eight when regulators boosted their target reserve requirement a week ago, according to Bloomberg. Since then people familiar with the matter, have said 10 of the 19 banks will be directed to raise capital, Bloomberg and the Wall Street Journal both reported.

Fed officials have reportedly raised the required amount of tangible common equity to about 4% of a bank's assets, up from the 3% mark established early in the process.

Banks that fail to meet government standards will have six months to raise the required capital. They will be able to do so by selling assets, drumming up private capital, or by converting the government's existing preferred shares into common stock.

Converting preferred shares into common equity would diliute the value of common shares, but that would be preferable to seeking more funds from the Troubled Asset Relief Program (TARP), which would almost certainly come under the condition of more executive firings and pay restrictions.

The Treasury has about $110 billion in TARP funding left to offer, Bloomberg reported.

Banks were given preliminary results of the stress tests last month, and the final results were originally scheduled for release Monday, but the Fed postponed their release after several banks objected to the findings.

Citigroup, for instance, argued that regulators hadn't given the bank enough credit for its efforts to offload several of its smaller units, including Smith Barney and Nikko Cordial Securities, its Japanese brokerage arm.

On Friday, Citigroup agreed to sell Nikko Cordial Securities to Sumitomo Mitsui Financial Group (OTC: SMFJY) for about $5.5 billion. The deal, which is to be completed by Oct. 1, also includes a transfer of about $2 billion in excess cash from Nikko Cordial to Citigroup.  

The deal will boost the bank's Tier-1 capital ratio by approximately 27 basis points.

Citi also has expressed frustration with the investigation into its finances.

Executives who met with regulators at the New York Federal Reserve headquarters when the banks were first made aware that they would be asked to raise more capital, say they still don't understand the government's methodology.

News and Related Story Links:

• Money Morning:
  Money Morning's Bank Stress Test Says These Three Banks Are the Strongest

• Money Morning:
  Motivations Abound for Federal Reserve's Delayed Release of Bank Stress Test Results

• Bloomberg:
  Fed Stress Tests to Show About 10 Banks Need Capital

• Wall Street Journal:
  More Banks Will Need Capital