Fed will seek bank capital increase

Fed will seek bank capital increase
By Krishna Guha in Washington and Francesco Guerrera in New York
Copyright The Financial Times Limited 2009
Published: April 24 2009 19:19 | Last updated: April 25 2009 03:18
http://www.ft.com/cms/s/0/cab07cf6-30fb-11de-8196-00144feabdc0.html


Some of the country’s biggest banks will be asked to raise more capital by US authorities following the completion of bank stress tests, senior Federal Reserve officials said on Friday.

A second, larger, group of leading banks will be asked to improve the quality of their capital by increasing their amount of common equity, the officials indicated.

Meanwhile, people familiar with the situation said regulators indicated that Citigroup might need more capital beyond a planned conversion of preferred shares into common stock that will give the government a 36 per cent shareholding.

If Citi has to raise more funds from the government, the authorities might force out Vikram Pandit, its chief executive. However, they added that no decision had been made and each bank had a week to discuss the results of the tests with regulators. Citi declined to comment.

While banks will be encouraged to raise the equity needed from the market, those unable to do so may have to ask the government to convert the preferred shares it holds in them into common equity. This could result in the US government ending up owning – at least temporarily – stakes in a number of the top US financial institutions.

Representatives from each top bank were summoned to the New York Fed on Friday morning to hear the stress test results.

A Fed white paper on the tests revealed that regulators ignored recent changes that water down mark-to-market accounting rules when assessing how much of a capital buffer each bank needs to ensure that it could comfortably survive a deeper recession than expected.

This is likely to result in some banks having to raise more equity than they would have done if the new accounting guidance had been applied, resulting in a stronger capital buffer but also greater dilution for existing shareholders.

Regulators also took an expansive view of the risks banks need to hold capital against, including off-balance-sheet exposures and counterparty credit risks, as revealed in Friday’s Financial Times.

The Fed officials said almost all the top 19 banks well exceeded requirements for quantity and quality of capital right now. However, the stress test is a forward-looking assessment. To meet the potential needs it identified, regulators want to see substantial buffers above the levels set out in minimum capital ratios.

Examiners looked at loan losses over two years plus an appropriate level of reserves required at the end of that period under an adverse economic scenario. They examined each private-label mortgage-backed security individually for likely impairment, and evaluated trading positions and counterparty risks based on a shock similar to that which occurred in the second half of 2008.

The capital buffer needed was based on the risks a bank was running, using a common formula.

Bank supervisors will work with the banks to maintain the capital buffer once established, the Fed officials said, although banks would be able to draw down their capital if and when losses mounted.

The Fed officials said the stress test was intended to prepare banks to comfortably survive 85 to 90 per cent of likely economic outcomes when its parameters were set in February, though they acknowledged that the economic outlook had deteriorated since then.

Some analysts expressed disappointment on Friday that the Fed had not told them what loan loss rates it applied to different categories of assets and had not given a target end point in terms of for instance, the ratio of common equity to risk-weighted assets it wanted banks to hold at the end of the two year period.