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Don’t sweat the bank stress test results

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There were no surprises in the stress test results as data had been leaked for several days ahead of the formal announcement. The government says that 10 of the 19 bank holding companies subjected to the stress tests need to add, in total, approximately $75 billion in capital to withstand a worst-case scenario.

Bank stress test results
Bank holding company Capital needed
American Express Co. No need
Bank of America Corp. $33.9 billion
BB&T Corp. No need
The Bank of NY Mellon Corp. No need
Capital One Financial Corp. No need
Citigroup Inc. $5.5 billion
Fifth Third Bancorp $1.1 billion
GMAC LLC $11.5 billion
The Goldman Sachs Group Inc. No need
JPMorgan Chase & Co. No need
KeyCorp $1.8 billion
MetLife Inc. No need
Morgan Stanley $1.8 billion
PNC Financial Services Group Inc. $0.6 billion
Regions Financial Corp. $2.5 billion
State Street Corp. No need
SunTrust Banks Inc. $2.2 billion
U.S. Bancorp No need
Wells Fargo & Co. $13.7 billion
Source: The Federal Reserve

To sum up, the nation’s 19 largest bank holding companies were tested under a couple scenarios to see if they have the financial wherewithal to withstand another two years of potentially significant economic deterioration.

Nine of the 19 — JP Morgan Chase, Goldman Sachs, MetLife, State Street, Bank of New York Mellon, U.S. Bancorp, Capital One Financial, American Express and BB&T — were told that there is no need for them to raise additional capital.

The 10 remaining institutions must come up with varying amounts ranging from $600 million to $33.9 billion.

Banks that need to raise capital have until June 8 to devise a plan detailing how they will accomplish that task. They then have until Nov. 9 to raise the needed funding. If they can’t pony up the required amount, they’ll have to visit the government trough.

“We want the government involvement to be temporary and short lived with a clean, quick exit strategy so that these positions — these firms — are back operating with a stronger financial foundation, with private capital as quickly as possible. And we’re going to make it very clear as they go through this, that the government is going to stand behind the system and make sure they have the ability to meet their commitments,” said Treasury Secretary Timothy Geithner in a May 6 interview on “The Charlie Rose Show.”

If your bank is under orders to raise capital, you probably don’t need to spend any time worrying about it. The government says none of these institutions is insolvent. There’s no need to open accounts in another bank. The caveat, as always, is to keep your deposits within the FDIC insurance limits.

“From a consumer point of view, I just don’t think this is an issue,” says John Douglas, partner at Paul Hastings law firm in Atlanta and former general counsel to the FDIC.

“If Goldman Sachs is No. 1 on the list and Bank of America is No. 19, am I going to move my money from BofA to Goldman Sachs because that’s a better institution? That doesn’t make any sense because BofA is going to be plenty strong and the government has said it’s going to stand behind the institution.

“From an investor’s point of view, I’m appalled at this exercise. This is stuff that’s done routinely in banks behind the scenes between the examiner and the institution. To have it done in a semipublic fashion has not been helpful to our financial system. It causes the consumer to ask a bunch of questions that I just don’t think the consumer needs to worry about.”

Investors who own shares of the institutions may be spared seeing the dilution of their holdings.

Institutions that need to raise additional capital can swap preferred shares they issued to the government in exchange for TARP money for what’s called “mandatory convertible preferred.”

“It doesn’t dilute the existing common shareholders until that preferred is later converted into common,” says Greg McBride, CFA, senior financial analyst at Bankrate. “In the meantime, there is no additional dilution taking place because it’s just an exchange of existing securities, not an issuance of new securities. There’s nobody jumping in line ahead of you in the capital structure.

“When the TARP funds were issued, then-Treasury Secretary Henry Paulson basically cut in line in front of common shareholders to the tune of however many billions of dollars a particular institution needed in funding.”

Some have criticized the stress test scenarios for not being sufficiently adverse. In an opinion piece in The Wall Street Journal, Nouriel Roubini, an internationally recognized economics expert and a professor at New York University, estimates that losses on U.S. loans and securities is $3.6 trillion and that the financial system is near insolvency. He says that U.S. banks and broker-dealers account for more than half these losses and that the stress tests’ conclusions are too optimistic about the banks’ health.