(From http://www.bloomberg.com)
By Craig Torres and Dawn Kopecki
April 25 (Bloomberg) — Financial regulators may force many of the largest U.S. banks to raise new capital or conserve extra cash after accounting for assets held off their balance sheets.
The Federal Reserve yesterday released the methods used in stress tests on the 19 largest U.S. banks, which incorporated an accounting proposal that would bring about $900 billion onto lenders’ books.
The accounting change suggests most of the 19 will need to take some action to buttress their capital, analysts said. Stronger banks may keep dividend payments low or apply retained earnings, with others selling new shares to make up the amounts, they said.
“We think that most banks are going to have to raise capital through some or all of those means,” said Dino Kos, a former markets director at the Federal Reserve Bank of New York who is now a managing director at Portales Partners LLC, a New York research firm. “All of them will need to conserve capital through retained earnings.”
Karen Petrou, managing partner of Washington-based research firm Federal Financial Analytics, said banks may need as much as $70 billion in new capital just to cover the added burden of the accounting changes.
Preliminary Results
Banks were given preliminary results from the stress tests yesterday, with final results due for publication May 4. The 19 firms include Citigroup Inc., Bank of America Corp., Goldman Sachs Group Inc., GMAC LLC, MetLife Inc. and regional lenders including Fifth Third Bancorp and Regions Financial Corp.
Financial stocks advanced yesterday even as the report stopped short of indicating how much new money regulators will demand to be raised. The report said “most” banks have capital “well in excess” of regulatory requirements, without specifying how the stress tests would impact those levels.
The Standard & Poor’s 500 index rose 1.7 percent to 866.23, and the S&P 500 Financials Index, which includes 80 banks, insurers, brokers and credit-card firms, gained 2.5 percent. The financials index is down 62 percent since the start of 2008.
The report is part of a federal effort to restore public confidence in banks, some of which have seen their capital “substantially reduced” by the recession and financial crisis.
The assessments calculated the capital buffer the 19 biggest banks will need to keep making loans even if the economic downturn worsens this year and next. They also put a focus on common stock as a key component of capital.
‘Gradation’ Among Banks
White House Chief of Staff Rahm Emanuel said the tests will reveal “gradation,” with some being “very, very healthy” and others needing assistance. Emanuel made the comments in an interview on Bloomberg Television’s Political Capital With Al Hunt.
The Fed’s report said that a bank’s capital buffer assessment is “not a measure of the current solvency or viability of the firm.” Regulators have been concerned that the release of the test results may roil the shares of banks with the largest capital needs, people familiar with the matter have said in the past week.
While the report said that banks’ own assessments were “not necessarily consistent” with the estimates of the regulators, a Fed official added that the firms shouldn’t be surprised at the figures. The official spoke to reporters on a conference call on condition of anonymity.
Proposed Changes
In calculating the capital buffers, regulators accounted for off-balance sheet securities that banks will be incorporating in 2010 as a result of proposed accounting rules changes. Banks may bring on about $900 billion to their balance sheets as a result of the change by the Financial Accounting Standards Board. Supervisors boosted the risk-weighted assets in their assessments by $700 billion, the Fed said.
“The regulators have decided to err on the very cautious side, assuming FASB finalizes the rule and throws $700 billion of risk-adjusted assets into the capital calculation,” said Petrou of Federal Financial Analytics. That change, she said, “makes the test considerably more stringent.”
“We conclude that it will be very, very difficult for any big bank to get out” of the government’s capital assistance program, she added.
JPMorgan Chase & Co., Bank of America, Citigroup and Wells Fargo & Co. are among the major banks with off-balance-sheet assets, analysts said.
Share of Market
The 19 banks in the test hold two-thirds of the assets and more than one-half of the loans in the U.S. banking system, the study said.
Regulators used a consistent metric for all the firms to measure how much of an additional capital buffer is needed over standard regulatory ratios of capital to risk-weighted assets, officials said, declining to identify what the measure was.
The Fed officials said supervisors will work with banks to maintain the buffer over time, indicating that firms with high- risk portfolios will face a larger challenge to maintain it.
Regulators used the market shocks of the second half of 2008, when Lehman Brothers Holdings Inc. declared bankruptcy, as the model for testing banks with trading portfolios of $100 billion or more.
Supervisors will weigh how much capital each company holds, its ability to retain earnings over the next few years, future access to private capital and the extent any asset writedowns.
Taxpayer aid for a troubled bank will come from the Treasury’s $700 billion Troubled Asset Relief Program for banks that need a stronger buffer. The Treasury is also open to converting its current preferred shares into common equity, a step that would boost capital levels and reduce banks’ dividend payments.
To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Dawn Kopecki in Washington at dkopecki@bloomberg.net;