The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation’s biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.

In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

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from Reuters:

At least half of the banks pushed back against the preliminary findings of the tests, the Wall Street Journal said, citing people with direct knowledge of the process.

Citigroup’s capital shortfall was reduced to $5.5 billion from about $35 billion after bank executives persuaded the Fed to include future capital-boosting impacts of pending transactions, the story said.

Wells Fargo’s shortfall was cut to $13.7 billion from $17.3 billion and Fifth Third’s was reduced to $1.1 billion from $2.6 billion.

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This afternoon, the Federal Reserve and the national banking agencies released the results of the stress tests – the most comprehensive, forward looking review of our nation’s largest banks ever undertaken. These tests will help ensure that banks have a sufficient capital cushion to continue lending in a more adverse economic scenario. They will provide the transparency necessary for individuals and markets to judge the strength of the banking system.

This capital assessment is an important part, but just one part of the President’s comprehensive plan to stabilize and repair the financial system and help get credit flowing again. Over the last three months, we have put in place a series of programs to address the housing crisis, to help restart the securities markets that are critical to business and consumer lending, to catalyze small business lending in particular, and to help create a market for legacy real estate related loans and thereby help clean up bank balance sheets. 

Alongside these programs, we have worked to restore confidence in the banking system. The assessment announced today will help strengthen the lending capacity of banks, with greater transparency and actions to reinforce the amount of capital banks hold against the risk of future losses. Capital is critical to lending. Each dollar of capital generates up to 12 dollars of lending capacity. And each dollar of lending capacity helps businesses grow and reduces the cost of borrowing for firms and families.

• Greater disclosure will help improve confidence. Today’s results should make it easier for investors to evaluate risk and to differentiate across institutions. The stress test will help replace the cloud of uncertainty hanging over our banking system with an unprecedented level of transparency and clarity. This is important, as markets work best when they have full access to the information on which to make informed investment decisions. With better disclosure, private capital is more likely to flow into the financial system, which will accelerate the point at which banks can replace the government’s investments.
• Banks will be given a range of options to ensure they have a substantial capital cushion. Some institutions will be required to take steps to improve the quality and/or the quantity of their capital to give them a larger cushion to support future lending even if the economy performs worse than expected. These institutions have a range of options to raise capital in the private markets, including common equity offerings, asset sales and the conversion of other forms of capital into common equity. If these options are not sufficient, they can request additional capital from the government through Treasury’s Capital Assistance Program. Banks must submit a detailed capital plan to supervisors, who will consult with Treasury on the development and evaluation of the plan.
  
• Some banks will be able to begin to repay the government. Those institutions that do not need to raise additional capital will have the opportunity to repay the government’s existing capital investments. To do this, they will need to demonstrate that they are able to issue debt without FDIC guarantees, as some banks have already begun to do.

Going forward, in the event that financial institutions need significant government assistance in terms of the quantity or composition of capital, then in consultation with supervisors, Treasury will evaluate whether existing board and management are strong enough to restore the firm to viability without government assistance. Where Treasury does take common equity, we will seek to return the company to purely private ownership as quickly as possible, and will be guided by the basic principle that the best way to serve the interest of shareholders and taxpayers is to exert our influence only on core governance issues and not on day-by-day operations.

• This was a carefully designed, credible test. Banks supervisors applied a historically high set of loss estimates on securities and loans, as well as a conservative view towards potential earnings that could act as a buffer against those losses. Taking into account the banking system’s existing capital and reserves, the public now has a better idea of how much capital banks will need to ensure they have sufficient capacity to continue providing credit in a more adverse economic downturn. These are estimate of potential losses and earnings that could occur in the event of a more severe recession. They are not a prediction of where the economy is headed. The results are less acute than some had expected, in part because concern about the risk of a more severe recession have diminished, market have improved, and banks, in anticipation of the release of the stress test, have acted in the last few months to increased capital.
  
• The banks that did not undergo the stress test will have access to capital on the same terms as the largest banks. To this end, the deadline for access to the preferred stock issued under the existing CPP has been extended for an additional six months, and Treasury will continue to examine other ways to ensure that small banks across the country can access capital so that they can continue providing credit to their communities. Supervisors will not extend the stress test to the rest of the banking system.

Our government has taken extraordinary actions to ensure the stability of our banking system because this is essential to contain the risk of a worse recession and to lay the foundation for a sustainable recovery.

With this support, and with the clarity provided by today’s announcement, banks should be able to get back to the business of banking. Those in leadership positions in our banks are going to have to work hard to repair the loss of confidence in the financial system and regain the public’s trust. They can do this by expanding lending to creditworthy families and small businesses that we depend on to generate economic growth. And they need to demonstrate that they are reforming compensation practices to reinforce limits on future risk taking. And this responsibility must be felt by all banks, including those that hope to be in a position to repay the government’s capital investments. 

Today’s stress test results are an important step forward in the Administration’s plan to lead us on the path to economic recovery. Americans should know that the government stands behind the banking system and that their deposits are safe. The actions taken by Congress, the FDIC and the Federal Reserve have improved market confidence and reduced the threat of systemic risk. Mortgage rates have fallen to historic lows, home refinancing has increased significantly, credit spreads have narrowed and companies in recent weeks have found it easier to issue debt to finance new investments.

This is just a beginning, however. Even with the recent signs of stabilization in economic activity, the economic still faces significant risks and challenges. The cost of credit remains exceptionally high. We have more work to do, and recovery will take time. But we are starting to see some signs of progress toward financial repair, and we will continue to work to expand the availability of credit and improve the impact our new set of credit and lending programs. 

This afternoon marks the culmination of the Supervisory Capital Assessment Program. Three independent federal banking supervisory agencies–the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation–have worked closely and collaboratively since late February to simultaneously assess the financial conditions of the 19 largest bank holding companies in the United States. These institutions play a vital role in our economy, holding among them two-thirds of the assets and more than one-half of the loans in the U.S. banking system. More than 150 examiners, economists, accountants, and other specialists conducted a rigorous and comprehensive review of these firms, one unprecedented in scale and scope.

These examinations were not tests of solvency; we knew already that all these institutions meet regulatory capital standards. Rather, the assessment program was a forward-looking, “what-if” exercise intended to help supervisors gauge the extent of the additional capital buffer necessary to keep these institutions strongly capitalized and lending, even if the economy performs worse than expected between now and the end of next year.

The results released today should provide considerable comfort to investors and the public. The examiners found that nearly all the banks that were evaluated have enough Tier 1 capital to absorb the higher losses envisioned under the hypothetical adverse scenario. Roughly half the firms, though, need to enhance their capital structure to put greater emphasis on common equity, which provides institutions the best protection during periods of stress. Many of the institutions have already taken actions to bolster their capital buffers and are well-positioned to raise capital from private sources over the next six months. However, our government, through the Treasury Department, stands ready to provide whatever additional capital may be necessary to ensure that our banking system is able to navigate a challenging economic downturn.

The capital assessment results we are reporting today are just one important element of the government’s broader and ongoing efforts to strengthen the financial system and the economy. The current crisis has been one of the most challenging financial and economic episodes in modern history, but we face no problems that cannot be overcome with insight, patience, and persistence. The Federal Reserve, through its independent actions and in collaboration with the other agencies represented here, will certainly do its part in our common effort to restore stability and prosperity.

While some of the lenders may need extra cash injections from the government, most of the capital is likely to come from converting preferred shares to common equity, the people said. The Federal Reserve is now hearing appeals from banks, including Citigroup Inc. and Bank of America Corp., that regulators have determined need more of a cushion against losses, they added.

By pushing conversions, rather than federal assistance, the government would allow banks to shore themselves up without the political taint that has soured both Wall Street and Congress on the bailouts. The risk is that, along with diluting existing shareholders, the government action won’t seem strong enough.

From Reuters:

The U.S. Treasury Department is planning to delay the release of any completed bank stress test results until after the first-quarter earnings season to avoid complicating stock market reaction, a source familiar with Treasury’s discussions said on Tuesday.

The Treasury is still talking about how results of the regulatory stress tests on the 19 largest U.S. banks will be released, and may disclose them as summary results that are not institution-specific, the source said.

The government is testing how the largest banks would fare under more adverse economic conditions than are expected in an attempt to assess the firms’ capital needs. The tests are due to be completed by the end of April, but Treasury has said they may be finished before then.

The source, speaking anonymously because the Treasury has not made a final decision on what to disclose, said officials do not want any test results released before the earnings season wraps up for most U.S. banks on April 24.

Entire story here.