Feds telling banks how they did on ‘stress tests’

updated 9:26 a.m. ET May 5, 2009

WASHINGTON - 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."

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.

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