Stress-Test Briefings for Lenders to Begin Friday

By DEBORAH SOLOMON and DAMIAN PALETTA WASHINGTON -- Regulators will begin briefing banks Friday about how they fared in government-performed "stress tests," giving lenders an opportunity to debate the findings before they're made public a week later, according to government officials. The discussions will signal to some banks whether they'll need to seek additional capital, either from private investors or the Treasury Department. The stress tests seek to measure a bank's ability to continue lending under extreme economic conditions. To help shore up confidence in the banking sector, the government is expected to distinguish between banks that need more capital and those able to withstand a worse and prolonged economic downturn. On Tuesday, Treasury Secretary Timothy Geithner said "the vast majority" of banks could be considered well-capitalized. But he also said the impact of the government's efforts to ease the financial crisis so far had been "mixed." Some indicators, such as interbank lending, "have improved significantly in the past few months," Mr. Geithner said in testimony before a congressional panel overseeing the Troubled Asset Relief Program, the Treasury's financial-sector rescue vehicle. But he said other areas, such as credit-card and commercial loans, remain troubled. "It is also important to point out that the cost of credit and terms of credit, even where they have recently declined, are still elevated," Mr. Geithner said. In the stress tests, regulators used some estimates of likely losses on loans that were tougher than observers had expected. Under a more adverse scenario, which assumes a 10.3% unemployment rate at the end of 2010, banks would have to calculate two-year losses of up to 8.5% on their first-lien mortgage portfolios, 11% on home-equity lines of credit, 8% on commercial and industrial loans, 12% on commercial real-estate loans and 20% on credit-card portfolios, according to a confidential document the Federal Reserve gave banks in February that was viewed by The Wall Street Journal. Regulators are expected to have used other assumptions as well when measuring a bank's strength. Such scenarios could make banks with heavy exposures to these products appear weaker than expected. "It's bad news because it's going to make the banks look worse off than people think," said Paul Miller, a managing director and head of financial-institutions research at FBR Capital Markets. To help coax private investment into banks, the government may separate firms into several groups based on their projected capital levels at the end of 2010. One possibility would be to group the banks by their ability to repay funds they received from the Troubled Asset Relief Program. The healthiest banks would be allowed to repay the money while the weakest banks would be directed to raise more capital. Those in between would be urged to not repay TARP funds now. The government plans to release on Friday an outline of how the tests were conducted, including the assumptions that regulators used to measure a firm's health. On May 4, some results of the tests are expected to be made public, though it isn't clear exactly how much information will be revealed. Mr. Geithner said Tuesday the government will provide as much capital as banks need to continue lending. But with limited bailout funds at its disposal, the Obama administration would prefer that banks raise money from the private market. "If a judgment is made, in consultation with management, that a bank needs additional capital, it will be encouraged to raise that capital from private sources," Mr. Geithner said in his testimony. The government will provide additional capital in the form of convertible preferred stock "as a backstop until private capital becomes available," he said. To help banks that need to bolster common equity in order to better withstand losses, the government may convert its preferred stakes into common shares. But such a move would raise thorny issues about how active an investor the U.S. government should be. Another way the government could help banks keep capital levels up would be to forgo the 5% dividend the government is due as a shareholder in banks that took TARP money. Of the biggest banks facing government scrutiny, analysts expect J.P. Morgan Chase & Co. and U.S. Bancorp to emerge among the strongest. Large regional banks are expected to face the biggest challenges. —Robin Sidel and David Enrich contributed to this article. Write to Deborah Solomon at deborah.solomon@wsj.com and Damian Paletta at damian.paletta@wsj.com