U.S. regulators are working with the top 19 banks on Tuesday to put the final touches on the results of regulatory stress tests, which are expected to reveal about half the banks need more capital but face manageable losses.
The results -- due to be unveiled on Thursday -- will likely show that the largest U.S. banks do not need dramatic new government interventions, which could further drive the recovery of banks' stock prices and signal an exit strategy for the government's intimate involvement in the sector.
Federal Reserve Chairman Ben Bernanke told lawmakers on Tuesday that those banks needing to raise more capital can do so through the private sector.
I've looked at many of the banks and I believe that many of them will be able to meet their capital needs without further government capital through either issuance of new capital or through conversions and exchanges or the sales of assets and other measures that would raise capital, Bernanke said.
Michael Poulos, head of the financial services practice at consulting firm Oliver Wyman, said the markets are also looking more positively at the banks undergoing the stress tests. He said investors have mostly priced in what they expect to see.
My sense is that where they've come out is more optimistic in terms of the ability of banks to recapitalize, Poulos said. If you look at the biggest banks, their prices have tripled from the bottom, and I'm not expecting them to move much on Thursday.
The KBW Banks stock index, which includes about two dozen large banks, was trading down about 2 percent in morning trading on Tuesday but has almost doubled from its year-low seen on March 6.
About 10 of the banks will likely be directed to aim for a higher capital ratio that puts more emphasis on common equity, which is thought to better absorb losses, according to a source familiar with official talks.
Regulators plan to release the results late Thursday in a 150-page document with Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner on hand to explain the findings.
The banks will be given time to issue detailed plans to raise capital, but markets are expected to drive them to quickly show investors that they have a realistic recovery strategy.
Poulos said banks will have one month to come up with their capital recovery plans after the test results are announced.
Some of the banks have been told they will be allowed to publicly talk about their results later on Thursday, lifting a gag order that the banks have been under since regulators briefed the firms on their preliminary results on April 24.
The results are expected to show a wide range of capital needs, and could expose significant vulnerabilities and looming credit losses at some firms.
Citigroup has been told it will need to boost its common equity by about $10 billion, a person familiar with the matter said Monday.
Reports have also indicated that Bank of America and Wells Fargo will be among the banks needing to boost their reserves, to gird themselves against a further deterioration in economic conditions.
The banks will come up with a mix of solutions to reach the target capital ratios but the new government infusion facility will not be banks' top option.
I think everyone involved will be looking for banks to raise this through either private means or the selling of some assets that they have or that they control, White House spokesman Robert Gibbs told reporters on Monday.
Banks will largely be expected to heal on their own, as the administration has said it would like an exit strategy as soon as possible from the banks, as long as it does not hamper the recovery effort or constrain lending.
Those firms that cannot get sufficient interest from the private markets will be allowed to turn to the government for further aid, likely by converting the government's preferred stakes to common equity.
For an institution like Citigroup, that could result in the government owning more than a 50 percent stake. But the government is expected to try to further step into banks for fear that it could be difficult to back out.
I think the ultimate purpose of the tests was obviously always to increase certainty and to give the markets a sense of where the bottom would likely be not only in terms of credit losses but also government intervention, Poulos said.
(Reporting by Karey Wutkowski with additional reporting by Dan Wilchins and Jennifer Ablan in New York, Editing by Chizu Nomiyama)