Investors braced for the release of bank stress test results that will separate the weak from the strong and force some top banks to raise billions of dollars in capital.
The test results -- due at 5 p.m. EDT -- are the culmination of a months-long exercise aimed at tackling one of the thorniest problems of the U.S. financial crisis: how to revive top banks and get credit flowing again.
The government tests of the ability of the 19 largest U.S. banks to weather a deep recession were expected to show about half the banks need more capital.
Federal Reserve Chairman Ben Bernanke described the tests as a fair and comprehensive effort that he hoped would allow markets to have greater confidence that they know the condition of the banks.
(Markets) can be reassured that banks will be strong and be able to lend even if the economy is worse than currently expected, he said.
Phil Orlando, chief equity market strategist at Federated Investors in New York, said on Wednesday, What this does is that it begins to give investors some clarity that we are starting to separate the wheat from the chaff.
Treasury Secretary Timothy Geithner, who along with other top regulators will brief the media on the stress test results, said in an opinion piece in The New York Times that the tests applied exacting loss estimates and conservative earnings estimates, an apparent rebuff to critics who have questioned whether the tests were tough enough.
Congress last year approved $700 billion in government aid for the battered U.S. financial sector under the Troubled Asset Relief Program.
President Barack Obama's fiscal 2010 budget, unveiled on Thursday, includes a $250 billion placeholder for additional financial rescue efforts, but White House budget director Peter Orszag said he hopes it will not be necessary to use this money.
Obama's team appears to have managed market expectations well, getting the worst news from the stress tests out two days ago -- that Bank of America needs as much as $34 billion in common equity capital.
I think things feel a little better, Geithner told PBS' The Charlie Rose Show on Wednesday. I think people sense a bit more stability. And you can see it in behavior. People are spending a bit more. Investors, companies are starting to borrow again so they can start to make investments again.
But skeptics still abound.
Although there are signs of economic improvement, they are not yet strong enough to suggest that the banking industry will not need significant capital in addition to the Treasury-announced capital requirements, analysts at Keefe, Bruyette and Woods wrote in a note to clients.
Regulators have told Bank of America Corp it needs $34 billion, while Citigroup Inc needs $5 billion and auto and mortgage lender GMAC LLC needs $11.5 billion, according to sources familiar with the matter.
Citigroup's capital needs reflect its previously announced plan to convert some preferred shares into common stock.
Wells Fargo needs $15 billion, Morgan Stanley needs $1.5 billion, and Regions Financial Corp needs some capital, The Wall Street Journal said.
Bank of New York Mellon Corp does not need capital, a person familiar with the matter said.
American Express Co, Capital One Financial Corp, Goldman Sachs Group Inc, JPMorgan Chase & Co and MetLife Inc also do not need capital, the Journal said.
All the companies declined to comment. The various sources reporting the stress test results were not authorized to speak because the results are not yet public.
VOLATILE BANK STOCKS
Among banks needing equity capital, Bank of America shares were up 8 percent in afternoon trading on the New York Stock Exchange, while Wells Fargo & Co fell 7.4 percent.
Now we know which companies are capital deficient and how much they need to raise, this is beginning to shift the focus away from the banks' capital structure to how much they can earn in the future, said Bill Hackney, managing partner at Atlanta Capital Management with $6.4 billion under management.
But some investors believe financial stocks may fall again.
From my perch, investors should sober up and reduce their holdings in financials now, hedge fund manager Doug Kass said in a note to clients. Financial stocks are now priced to perfection, he added. In an interview, Kass said he is selectively selling short some bank stocks.
Shares of JPMorgan and Goldman, which are not expected to need to raise common equity, fell 4.9 percent and 3.6 percent, respectively.
The sectoral KBW Banks index slid 1.9 percent after rising about 1 percent earlier in the morning.
Banks may cover any capital shortfalls through a mixture of asset sales, share sales and perhaps the conversion of preferred shares into common stock.
The government is giving banks needing capital one month to develop a plan to raise it, and until November 9 to finish the job. The banks must also review their management and boards of directors to ensure proper leadership.
Banks like Goldman and JPMorgan, which have said they want to repay TARP funds received last fall, cannot return the aid until they issue debt not backed by the federal government, and for more than a five-year term.
If a bank raises common equity by converting preferred shares issued under TARP, the government could become one of the bank's biggest shareholders. The White House said it would await the stress test results before commenting on banks' potential management changes.
Analysts at Goldman Sachs estimated that banks' capital needs after the stress tests would total $130 billion, with $100 billion needed by weak banks to plug holes and $30 billion needed by stronger banks to repay TARP funds.
Analysts believe other banks that may need capital include Fifth Third Bancorp, KeyCorp, PNC Financial Services Group Inc and SunTrust Banks Inc.
(Additional reporting by Jonathan Stempel, Paritosh Bansal, Elinor Comlay, Ellis Mnyandu, Dan Wilchins and Jennifer Ablan in NEW YORK; Karey Wutkowski, Mark Felsenthal, David Lawder, Glenn Somerville and Jeff Mason in WASHINGTON, D.C.; Douwe Miedema in LONDON; and Michael Flaherty and Parvathy Ullatil in HONG KONG; Editing by John Wallace)