Fed Determines 10 Banks Need Capital of $74.6 Billion

The Federal Reserve determined that 10 U.S. banks need to raise a total of $74.6 billion in capital, a finding that Chairman Ben S. Bernanke said should reassure investors about the soundness of the financial system.

The results showed that losses at the banks under “more adverse” economic conditions than most economists anticipate could total $599.2 billion over two years. Mortgage losses present the biggest part of the risk, at $185.5 billion. Trading accounts were the second-largest vulnerability, with potential losses of $99.3 billion.

The conclusion of the unprecedented probe of the health of the largest 19 lenders opens an exit for some of the firms from a tense partnership between Wall Street and the government. Others will have six months to fill their capital shortfalls and may be forced to accept expanded federal ownership that could prompt changes in their management.

“The results released today should provide considerable comfort to investors and the public,” Bernanke said in a statement. “The examiners found that nearly all the banks that were evaluated have enough Tier 1 capital to absorb the higher losses envisioned under the hypothetical adverse scenario.”

Common Equity

Almost half of the banks “need to enhance their capital structure to put greater emphasis on common equity,” the Fed chief said.

The total loss rate for loans calculated by the regulators under the “more adverse” economic scenario was 9.1 percent, a level that exceeds that seen in the 1930s, according to the Fed. The tests were “deliberately stringent” and designed to account for “the highly uncertain financial and economic conditions,” the central bank said.

The reviews showed that supervisors can work together to make rapid assessments about risks embedded in the U.S. financial system, as lawmakers and the Obama administration consider an overhaul in regulations later this year. Bernanke and other agency heads insisted on transparency, overcoming the tendency of supervisors within their institutions to avoid public disclosure.

After an internal debate, the regulators decided to publish firm-specific results themselves, rather than risk letting private accountants and lawyers manage the outcome.

Capital Shortfalls

Bank of America Corp. was judged to need $33.9 billion in additional capital under regulators’ criteria, the largest gap. Wells Fargo & Co.’s shortfall is $13.7 billion, while Citigroup Inc.’s gap is $5.5 billion. New York-based Citigroup has already announced plans to bolster its tangible common equity ratio by converting some of its preferred shares into common stock.

Fifth Third Bancorp’s capital need is $1.1 billion, KeyCorp’s is $1.8 billion, PNC Financial Services Group Inc.’s is $600 million, Regions Financial Corp.’s is $2.5 billion and SunTrust Banks Inc.’s is $2.2 billion. GMAC LLC needs $11.5 billion, while Morgan Stanley’s assessment was $1.8 billion.

Goldman Sachs Group Inc., JPMorgan Chase & Co., Bank of New York Mellon Corp., MetLife Inc., American Express, State Street Corp., BB&T Corp., US Bancorp and Capital One Financial Corp. were deemed not to need additional funds, according to the results.

Loan Risk

Residential mortgages and consumer loans, including credit cards, “account for $322 billion, or 70 percent of the loan losses projected under the more adverse scenario,” the Fed said in its report.

Banks that need to raise capital under the government’s stress tests will have until June 8 to develop a plan and until Nov. 9 to implement it.

“The next question is, ‘Is it enough?’” said Ralph Cole, a money manager at Portland, Oregon-based Ferguson Wellman Capital Management Inc., which oversees $2.2 billion. “Now they have to go about executing in the middle of a recession.”

Several banks announced capital-raising plans. Wells Fargo said it will sell $6 billion of common stock. Morgan Stanley plans to raise $2 billion in a share sale and $3 billion by selling debt that’s not guaranteed by the government.

Bank of America said it doesn’t plan to exchange existing government preferred shares into common stock, which would have increased the federal stake in the Charlotte, North Carolina- based lender.

‘Aptly Named’

“Never has a test been so aptly named,” Bank of America Chief Executive Officer Kenneth D. Lewis said in a conference call after the results were released.

Senator Jon Kyl of Arizona, the Senate’s No. 2 Republican, said “we were assured” during debate on the financial bailout last year the government wouldn’t “gradually be taking over the management of companies.” He spoke in an interview taped for Bloomberg Television’s “Political Capital with Al Hunt.”

Bank stocks rose in late trading. Citigroup climbed 7.1 percent to $4.08 at 6:40 p.m. in New York. Bank of America gained 9.3 percent to $14.76. U.S. stock-index futures gained, with Standard & Poor’s 500 Index contracts expiring in June adding 0.6 percent to 912.20.

Officials put an emphasis in their reviews on tangible common equity, requiring the companies to have the equivalent of 4 percent of their assets after adjusting for risk. The financial yardstick strips out intangible assets, goodwill --the premium above net assets paid for acquisitions -- and preferred stock, including shares issued to the Treasury.

Target Ratio

Regulators also set a target for a Tier 1 ratio of 6 percent compared with risk-weighted assets, a broader measure of financial strength.

The Treasury has injected more than $200 billion of taxpayer funds into financial institutions in an effort to boost confidence and capital. Congress has increased scrutiny over the investments and passed legislation limiting bonuses at institutions supported by public cash.

The decision to launch the biggest financial bailout in history came on a Sept. 17 conference call between Bernanke and former Treasury Secretary Henry Paulson. Over the previous two days, they had allowed Lehman Brothers Holdings Inc. to fail and seized American International Group Inc.

The $700 billion Troubled Asset Relief Program, or TARP, was initially proposed as a vehicle to remove devalued mortgages and related securities from the banking system. As confidence in banks began to erode, the Treasury switched to a capital- injection plan.

Congressional Oversight

The money came with strings attached. Firms were reminded that they had to boost lending. Congress called eight banks’ chief executive officers to Washington in February to face criticism for outsized pay packages and executive perks.

In April, JPMorgan Chase’s Chief Executive Jamie Dimon called TARP “a scarlet letter” and said his bank was prepared to repay the money immediately.

Financial institutions that want to retire the government’s stakes must have capital consistent with the government-mandated buffer, the agencies said yesterday. They also must be able to demonstrate “financial strength by issuing senior unsecured debt for a term greater than five years not backed by FDIC guarantees,” the regulators said.

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, regulators said.

Examiners used an “adverse scenario” of a 3.3 percent decline in gross domestic product this year, and an average unemployment rate of 8.9 percent this year and 10.3 percent in 2010.

Forecasters see a 2.5 percent decline in output this year, and average unemployment rates of 8.9 percent this year and 9.4 percent next year, according to the median estimates in a Bloomberg News survey.

“There’s a race on now: Whoever gets to market first and has the most compelling story to investors will be able to raise capital,” said Mark Williams, a former Fed bank examiner who now teaches at Boston University’s School of Management. “For some of these banks, the thought of going back to the government may even force them into merging and finding partners.”