Two of four “stress-tested” banks operating in Colorado will need to boost their equity by billions of dollars to shield them against a deeper economic downturn, federal banking regulators said Thursday.
Wells Fargo & Co. must boost its equity by $13.7 billion and KeyCorp by $1.8 billion, according to the government. Two others that underwent the test — JPMorgan Chase & Co. and U.S. Bancorp — won’t need additional equity, regulators said.
Federal regulators tested how the nation’s 19 biggest banks would fare if unemployment rose to 10.3 percent by 2010 and home values on average fell another 22 percent this year and 7 percent next year.
Nine of those big banks have sufficient resources to weather the loan losses generated under the darker scenario.
The remaining 10, however, would need to raise $74.6 billion in equity.
Most could do that by converting preferred shares the government purchased last fall into common stock. They also could seek additional funds from private investors or the government if necessary.
“Things don’t look as bad as I was imagining,” said Marcelle Arak, a finance professor at the University of Colorado Denver. “I thought we would need another $700 billion. This isn’t a bottomless pit.”
Wells Fargo is confident
San Francisco-based Wells Fargo, which controls the largest share of Colorado bank deposits, said a decision to write off $40 billion in troubled loans from Wachovia, which it acquired at the end of last year, left it short of equity in the government’s eyes.
By taking a bigger hit on bad loans up front, the bank expects earnings to be stronger going forward and is confident it will meet regulatory requirements.
“By writing off those troubled loans last year, however, the Wachovia portion of Wells Fargo’s losses has been significantly reduced, supporting profitability and our ability to add more common equity over time,” chief financial officer Howard Atkins said in a statement.
Likewise, Cleveland-based KeyCorp said it has several options to raise equity, including converting preferred shares to common equity.
“The assumptions in the hypothetical stress test were extremely conservative, even for the more adverse economic scenario, and we believe that actual losses and earnings performance will be better than these test results,” said Henry Meyer, KeyCorp’s chairman and chief executive.
Having a financial system recognized as “strong and stable” was important, he added.
Regulators tested a scenario that put bank loan losses at 9.1 percent, a level slightly higher than the depths of the Great Depression.
Under that scenario, regulators estimated $600 billion in loan losses, including $102.3 billion from first mortgages, $83.2 billion from second mortgages and $82.4 billion from credit-card loans, which would suffer a 22.5 percent loss rate.
Commercial real estate loans would account for $53 billion in losses, an 8.5 percent default rate, while commercial and industrial loan losses would top $60.1 billion, a 6.1 percent default rate.
Arak said she could see a scenario where commercial real estate loan losses reach those projected levels, but not credit cards.
Level the playing field
When borrowers stop payment on loans, banks must set aside money in reserve and write off those losses against earnings. If severe enough, losses can deplete a bank’s capital, making it insolvent.
Regulators have applied strong pressure on community banks to boost capital, and the stress-test results will help level the playing field, said Denver banking consultant Larry Martin.
“It is nice to see the government requiring big banks to increase their capital,” he said.
Arak, who specializes in risk analysis, said she wishes regulators had stress-tested banks back when everyone assumed home prices wouldn’t fall and future recessions would be mild.
When the credit crisis worsened last fall, the government was reluctant to differentiate between weak and strong banks.
If investors trust the government’s calculation, they should be willing to invest in all banks knowing they can withstand a bigger shock, analysts said.
Banks have until June 8 to craft a plan to raise more equity and until Nov. 9 to implement it.
Aldo Svaldi: 303-954-1410 or asvaldi@denverpost.com
