Edgy Banks Start to Get Word Today on Stress Tests

Edgy Banks Start to Get Word Today on Stress Tests
By ERIC DASH
Published: April 23, 2009
Copyright by The New York Times
http://www.nytimes.com/2009/04/24/business/economy/24bank.html?th&emc=th


Wall Street is stressed out about stress tests.

After a two-month wait, the nation’s 19 largest banks will start learning on Friday how they fared in important federal examinations — and which among them will need another bailout from the government or private investors.

While many of the banks reported surprisingly strong first-quarter earnings, they are by no means out of the woods. A number of them are likely to need more capital to weather a prolonged recession, and the losses that might accompany it.

The Federal Reserve intends to disclose, in general terms, how it conducted the stress tests on Friday afternoon, but the government will not publicly reveal the results until May 4. In between, Wall Street is bracing for a possible roller-coaster ride in financial stocks as investors scramble to do their own assessment of the financial industry’s strongest and the weakest players.

“The headlines, not the details, seem to be driving the markets,” said Frederick Cannon, who is in charge of equity research at Keefe, Bruyette & Woods, a boutique investment bank.

Analysts are already betting that the stress tests will show that banks need to raise significant amounts of new capital, as profits made in the first three months of the year give way to more losses, tied to credit card, commercial real estate and corporate loans. An assessment by Mr. Cannon’s firm, which calculated its own stress test for the industry, concluded Thursday that United States banks might need as much as an additional $1 trillion in capital.

As part of their exam, regulators have been poring over bank balance sheets to spot financial problems that may not surface for months. Officials are assessing the financial condition of the banks based on their potential losses and earnings over the next two years. That is why some banks that recently announced blockbuster earnings may still need to raise sizable amounts of fresh money.

As the dust settles from the shakeout on Wall Street, the 19 banks subject to stress tests are starting to divide into three groups: the strong that can weather the storm; the weak that will need new, perhaps significant, support; and the ones on the verge, whose fate will be decided by regulators.

“Banks are starting to distance themselves from the pack,” said Gerard Cassidy, a longtime banking analyst at RBC Capital Markets. “The companies that pull away are going to be the companies that have the least amount of exposure to the riskiest areas, the strongest capital position and the best management teams.”

Those poised to withstand potential worsening of the recession — with little or no new capital — include major banks like Goldman Sachs and Morgan Stanley, which already swallowed multibillion-dollar losses on toxic securities and cut dividends to shore up their financial position. Big custodial banks, like Bank of New York Mellon and the State Street Corporation, which provide bookkeeping and securities lending to investment firms, also have probably put the bulk of their troubles behind them.

A handful of well-run commercial banks are thought to be members of this group. JPMorgan Chase, for example, set aside several billion dollars from strong first-quarter profits in investment banking to protect against an onslaught of corporate and consumer loan losses. U.S. Bancorp of Minneapolis plans to rely on its fat lending margins and fee-generating businesses to weather the recession.

At the other end of the spectrum are weaker banks, where ballooning losses threaten to overwhelm profits. Analysts say that some of these banks — including Bank of America and Citigroup, whose consumer and investment banking businesses have been pummeled — may need additional capital to shore up their finances.

Although Bank of America announced a first-quarter profit that exceeded expectations, analysts say that rising loan losses across its portfolio may threaten its health. If so, the bank may be forced to convert part of the government’s investment into common stock, over the objections of its chief executive, Kenneth D. Lewis.

Likewise, Citigroup’s credit card and consumer lending businesses are extremely vulnerable to a global downturn, although the bank still eked out a $1.6 billion first-quarter profit. In late February, it announced plans to convert a big part the government’s preferred shares into common stock to bolster its finances before its stress test. Even so, some analysts contend it still needs an additional stock infusion.

And a number of regional banks are bracing for huge losses in their commercial loan books, making them strong candidates for needing additional money. Fifth Third Bank Ohio of Cincinnati has struggled to keep up with spiraling losses on corporate loan and real estate, the result of the worsening on its Rust Belt home turf and an ill-timed expansion into Florida. SunTrust Banks of Atlanta and Regions Financial of Alabama have been hard hit by the housing bust that has affected much of the Southeast, and their problems with commercial real estate and corporate loans have severely worsened. But Regions, for example, added a mere $34 million to its reserves for future loan losses, an amount analysts say may not be enough to cover a surge in its nonperforming loans.

The rest of the lenders fit into a more uncertain category, where their need for capital depends on what federal officials decide.

As unemployment rises, big credit card players like American Express and Capital One Financial are having a spike in the number of customers defaulting on their loans. But by reining in credit limits, and having set aside big pools of money to cushion the blow, they may end up better off than traditional bank lenders.

Some large regional banks face a similar issue. BB&T Bank of North Carolina, PNC Financial of Pittsburgh, and Wells Fargo all posted surprisingly good first-quarter numbers, but some analysts have questioned their ability to cover future losses. Regulators are likely to make judgments on their capital needs.

Correction: April 24, 2009
An earlier version of this article incorrectly included BlackRock, which is not believed to be under review.