U.S. lays groundwork for bank stress test release

WASHINGTON Thu Apr 16, 2009 4:30pm EDT

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WASHINGTON (Reuters) - U.S. regulators on Thursday released some details about their bank "stress tests," moving to bolster the credibility of a process some investors worry might not reveal the financial sector's true health.

An official at the Federal Reserve said on Thursday that results of the tests, designed to see how the nation's 19 largest banks would fare should the U.S. recession prove unexpectedly severe, would be made public on May 4.

Regulators will try to prove the rigor of the tests by releasing a document on April 24 that will explain the underlying assumptions, the official said. The document will outline the methodologies employed and serve as a guide on how to interpret the results.

The test results will include a capital recovery plan for banks that regulators determine would be short of capital if the economy's downturn gathered steam and unemployment shot unexpectedly higher.

Experts say the results must be believable and the recovery plans clear, or officials risk further destabilizing the financial system in a way that will send the weaker banks into a downward spiral.

"There is a lot at stake," said Douglas Elliott, a former JPMorgan investment banker now with the Brookings Institution, a Washington think tank. "It's going to be important that this is viewed as a test that really has validity."

Regulators have not made final decisions on how to present the results, the Fed official said. Regulators will disclose at least some of the information, but no decision has been made on whether banks themselves will disclose some as well.

The official, who requested anonymity because the tests are still in process, added that the goal is to ensure that all the results are presented on a comparable basis.

The results are expected to distinguish which banks are strong and on the path to recovery, and which firms remain in need of government aid -- and subject to caps on executive pay and other restrictions. Stronger banks are likely to fare much better at attracting private capital and removing any stigma associated with taxpayer funds.

Some banks have already declared themselves among the strong.

JPMorgan Chase Chief Executive Jamie Dimon said on Thursday "we think we'll do fine under any stress tests measurement," adding that the bank could immediately repay the $25 billion it received from the government.

Goldman Sachs similarly trumpeted its health on Tuesday, saying it has a "duty" to repay $10 billion in taxpayer aid. It sold $5 billion in stock toward that effort.

Wells Fargo surprised the markets last week, saying it expected to post a $3 billion first-quarter profit.

TESTING STRESS, LEGITIMACY

Regulators plan to hold discussions with the banks about the standardized stress tests from April 24 through May 4, according to the official.

Once the test results are announced, banks found to need more funds will have six months to raise the capital from the private markets or can take an infusion of taxpayer money.

Announced in February, the tests are designed as an exercise to provide credible information on the health of the U.S. banking sector. Regulators hope that once investors have the results, they can accurately evaluate the health of banks' balance sheets, and private capital will return to the sector, stabilizing the financial system and increasing lending.

More than 200 examiners have spent weeks poring over the banks' portfolios and asset valuations.

James Wheeler, a partner on the financial institutions team at law firm Bryan Cave, said the stress tests have been much more extensive than routine stress tests conducted at banks. The current round involve extensive modeling of banks' loans and investments, include higher risk multiples, and project out further in the future, he said.

"It's not a new species but it certainly is the next generation," Wheeler said.

Treasury has laid out some details of the economic scenarios it used to stress test the banks, but the rigor of the test alone will not make the results believable, Brookings' Elliott said.

"Unless the test results show, in the aggregate, the need for at least $100 billion of capital, a lot of people aren't going to think the results are credible," Elliott said. "I can't imagine officials wanting it to be $300 billion, and it's not clear they could get the money from Congress."

Treasury has said any new capital injections would come from the $700 billion financial rescue fund approved by Congress in October. Treasury officials estimate they have about $134.5 billion they could still tap.

Some analysts and financial industry insiders think regulators will go beyond current plans to simply recapitalize

banks and take toxic assets off bank balance sheets. They see the possibility of management shake-ups, mergers and possibly even the unwinding of some large firms seen beyond repair.

A financial industry source, who spoke anonymously because of relationships with the top banks, said regulators will have to state clearly what will happen to the weaker banks with capital holes, or risk a severe market reaction.

"It's designed to inspire confidence, but creates a whole new set of expectations in the market that, if not met, can totally backfire," the source said.

(Reporting by Karey Wutkowski and Mark Felsenthal; Editing by Matthew Lewis and Tim Dobbyn)

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