Stress test released: Ten of 19 institutions must raise $74.6 billion
Stress test shows bank credit losses could be $600 billion
Ten of 19 institutions must raise $74.6 billion in private capital by November.
WASHINGTON -- Federal regulators released the long-anticipated, controversial stress tests on the health of the 19 largest financial institutions on Thursday, showing that the banking sector is secure, but under a pessimistic forecast, banks' credit losses over the next two years could be $600 billion.
According to the report, 10 institutions are ordered to raise $74.6 billion in private capital over the next seven months, slightly more than expected from unofficial reports on the test results. Two of the institutions -- Wells Fargo and Morgan Stanley -- have already announced plans to raise capital.
'These examinations were not tests of solvency; we knew already that all these institutions meet regulatory capital standards.'
— Fed Chairman Ben Bernanke
The bulk of losses based on the adverse economic scenario considered by bank regulators would come from residential mortgages and consumer-related loans. According to the tests, roughly $455 billion would come from residential and consumer related losses. Losses from trading divisions and investment portfolios could reach $135 billion, based on the Federal Reserve's adverse forecast.
Treasury Secretary Timothy Geithner indicated that banks have enough high-quality, "Tier 1" capital for now, but that credit losses will continue across asset classes. He pointed out that Tier 1 capital at these banks totaled about $835 billion in the fourth quarter, 2008. However, he added that could change.
"Banks will need strong capital to weather these losses while making loans," Geithner said.
If the adverse scenario plays out, with much higher unemployment and loss of wealth in housing markets, total loan losses could hit 9.1% of total outstanding loans, a worse loss rate than banks suffered at the height of the Great Depression in 1931-32.
Nevertheless, the report shows that the 19 banks held only $200 billion in mortgage- securities that were not backed by Fannie Mae or Freddie Mac. Only a portion of these assets were in "riskier non-prime mortgages," considered a key contributor to launching the global financial crisis. However, the report did not indicate how many assets were in this riskier category.
Geithner said the stress tests are a "one time" exercise. He said bank regulators will continue to use existing capital requirements for banks.
Both Geithner and Fed Chairman Ben Bernanke reiterated that based on their evaluation of the banks, they believed all 19 banks are well-capitalized for now.
"These examinations were not tests of solvency; we knew already that all these institutions meet regulatory capital standards," said Fed Chairman Ben Bernanke. "The results released today should provide considerable comfort to investors and the public."
Bernanke said he believed that many of the 19 institutions are well positioned to raise private capital over the next six months. It is expected that the banks that need to raise private capital will seek to do so first by selling shares to private investors. Other methods involve selling assets, such as mutual fund divisions, and by seeking to convert holdings by bondholders and private preferred shareholders into common shares.
Some banks may eventually need to convert government preferred shares into common shares and possibly receive further capital injections from the $109.6 billion left in the bank bailout fund.
Regulatory observers argue that Congress is not ready to allocate more taxpayer money to the fund, raising questions about whether the Treasury Department has enough capital to provide banks should a downturn occur. Nevertheless, Bernanke said the government is ready to provide further capital if needed.
"The government stands ready to provide whatever additional capital may be necessary to ensure that our banking system is able to navigate a challenging economic downturn," Bernanke said.
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