Wall Street traders, members of Capitol Hill and shareholders of battered financial stocks all breathed a collective sigh of relief this week as the government finally presented the long-awaited results of the stress testing that has been in progress for the last several weeks.
The results of the stress tests arising from the Obama administration’s desire to assess the fitness of the financial services sector have been highly anticipated and will help determine which of the nation’s largest banks are still at risk for further losses should the recession deepen.
Nineteen of the largest banks took part in the first wave of testing and federal regulators determined that ten of those need to raise additional capital to the tune of almost $75 billion in total. The results have generally been deemed a success by Wall Street and by the public but determining exactly who emerged from the tests in good shape and who has work left yet to do requires a look beyond the numbers from the government. With that, let’s look at some of the winners and losers from the stress tests.
Winner: Goldman Sachs and JP Morgan Chase
These two stalwarts are some of the nation’s longest running financial establishments and both passed the tests with flying colors. The government’s stamp of approval essentially puts these banks a step ahead of those requiring further capital and means that they can begin selling customers on their financial strength.
They can also begin to focus on repaying their share of capital obtained from the Treasury via the government’s Troubled Asset Relief Program. Goldman has already begun selling common stock to repay their share of TARP funds. Morgan appears ready to pay back their TARP money as well and have gone on record stating that they didn’t want to accept TARP money in the first place.
Loser: Goldman Sachs and JP Morgan Chase shareholders
For as well as the Goldman Sachs and JP Morgan Chase corporations fared in the stress tests, shareholders of these companies have to feel like they’ve gotten the short end of the stick this week.
For the week, Goldman Sachs shares were up about 10% while stock in JP Morgan Chase rose about 20%. While no doubt a fantastic return for one week, it’s not quite as astonishing considering that companies that failed the stress tests did considerably better. Citigroup was up 35%. Wells Fargo shot ahead 44%. Bank of America, which will be required to raise the most additional capital of any of the banks tested, was up an astounding 63%.
Winner: Government Regulators
At its advent, investors and Wall Street analysts were concerned about the legitimacy of the stress tests. Many worried that the assumptions used in the tests were arbitrary at best and that the government wasn’t really executing much of a test at all. They feared that the government would carry out an artificially simple examination in order to increase the perceived strength of the financial sector.
That, however, hasn’t appeared to be the case. Wall Street, as evidenced by the performance of financial stocks this past week, has responded with its approval and the public is praising the fact that at least some of the uncertainty surrounding the true health of the financial system has for the time being been addressed.
Loser: Bank of America
It’s hard to come up with a more obvious choice than the company that alone represents almost half the capital the industry needs to raise.
Bank of America needs to come up with an additional $33.9 billion in capital – almost as much as all of the other banks that failed the stress tests combined – and the results underscore the fact that B of A’s balance sheet still needs some cleansing before it can be considered healthy once again.
The Financial Times reported in an article published Thursday that Citigroup officials “convinced regulators to reduce their estimates of its capital shortfall from an original $30 billion plus to just $5.5 billion.”
If that’s true, they scored a major coup. The original $30 billion figure would have put them right next to Bank of America for needing capital. Instead, the $5.5 billion the government has asked them to raise can be accomplished relatively easily by converting existing preferred stock over to common shares. The need to come up with about $25 billion less in capital will also pay big dividends in perception alone.
Long-suffering holders of financial shares finally have some reason for optimism.
The stress test results were just the stimulus the sector needed to have one of its best weeks in recent memory. The KBW Bank Index was up 36% this week and has soared almost 135% since hitting its early March lows.
Moreover, the shroud of uncertainty and pessimism has finally begun to lift off of the entire industry. The results of the tests have given the public the feeling that the worst of the financial crisis may finally be behind us and that the government does indeed have the ability to steer us out of this mess.
The fact that over half of the banks tested need to raise additional capital merely highlights the fact that many financial firms still have a lot of work to do before complete recovery can be achieved. There’s no denying however that the feeling of optimism is starting to return and that is something that the financial sector hasn’t experienced in a long time.
Sources: Yahoo Finance, The Motley Fool