Much of the news in the market of late has revolved around stress testing. Yesterday, the Federal Reserve released the results of their Stress Testing on 19 financial institutions. The results of these tests will go a long way in determining the direction these firms head in and who will survive the current recession. Before going into the results, a little on the process and what stress testing is.
Stress testing is a computer simulation technique that tests how various scenarios could affect a bank's balance sheet. The testing accounts for past and future results and will give a good indication of how an institution will fare over the next few years. Based on these results, the Fed will require a bank to either raise more capital or repay the TARP (Troubled Asset Relief Program) funds that they received from the government.
Of the 19 institutions that were tested, ten will be required to raise over $70 billion by the Fed.They will have to raise this capital by converting preferred shares, selling assets or converting TARP funds into common stock. Among the banks that require the most capital, Bank of America needs over $30 billion and Citigroup will need over $5 billion.
The good news is that some of the institutions (Goldman Sachs and Morgan Stanley in paticular) are in a good position to repay the TARP funds they received. The repayment will depend on when the government will allow this to happen. The Fed looks at a repayment of TARP funds as a sign that these institutions could make lending more difficult because the government is no longer an active investor in the company. There are many that feel the opposite, that lending will be easier (banks will be able to dictate who they want to lend to; the government will have less say).
In the insurance sector, only one company was involved in stress testing, Metlife. It does not appear that Met will require any additional capital and did not participate in the TARP program.
