The stress test results are raising doubts that the government's next financial stability project — a plan to let banks get rid of toxic assets — is still needed.

Until last week, most expected that the stress tests would reveal a need for significantly more capital at the nation's 19 largest banks — capital holes that could be filled in part by forcing those institutions to sell assets through the public-private investment program.

Instead, the results showed that, of the 10 banks that do need more capital, only a few need to raise sizable amounts, casting doubt on whether they will need to participate in the asset sales program.

"It has to mean that the PPIP program is no longer necessary," said Chris Low, the chief economist at First Horizon National Corp.'s FTN Financial. "There's no pressing need to raise large amounts of capital. Given the fact that particularly the loans on bank balance sheets are still being carried well above the market value — the sense was that banks would only participate if they were desperate to raise cash."

The administration is poised to kick off two public-private programs this summer: one for whole loans, dubbed legacy loans, to be managed by the Federal Deposit Insurance Corp. (FDIC), and the other for securities, to be run by the Treasury.

Officials are expected to choose asset managers later this month to help run the securities component, while the FDIC is launching a pilot for the whole-loan component in June. The government will subsidize both programs, and plans to sell off assets at discount prices. But observers said Friday that the stress test results show few of the biggest banks would be good candidates for selling assets into the program.

The three banking companies with the largest capital holes to fill — Bank of America Corp., $33.9 billion; Wells Fargo & Co., $13.7 billion, and Cerberus Capital Management's GMAC , $11.5 billion — have indicated no plan to participate in the toxic asset program. Wells has said it would raise $6 billion in a stock offering and try to amass the rest out of profits. BofA said it would sell assets, starting with its stake in China Construction Bank; turn to private investors; seek joint ventures; sell up to 1.25 billion shares of common stock and rely on earnings. GMAC said it would use a combination of issuing common stock or mandatory convertible preferred shares and converting existing equity.

"They're making plans under the assumption that they may not have PPIP," said Dean Baker, the co-director of the Center for Economic and Policy Research. "They aren't banking on it, in other words."

Mark Calabria, the director of financial regulation studies at the Cato Institute and a former Senate Banking Committee economist under Sen. Richard Shelby, said the stress tests are likely to dampen interest in PPIP.

"For the vast majority of the 19 that would have been potential participants, I think this has got to lessen their desire to actually participate because, if you are an institution that doesn't have to raise any capital and you believe these assets to really have long-term value, then why sell them now?" he said. "There's a very good chance it never gets implemented. I wouldn't be shocked if it dies a quiet death."

Joseph Rizzi, a senior investment strategist at the New York private-equity firm CapGen Financial Group, said the test results "make PPIP more problematic for the gang of 19. They no longer have the pressing need to take more aggressive marks. Thus, they will hold for higher prices than buyers are willing to pay, and there will be no trade."

Though observers have questioned how much pressure the government would apply on entities to participate, many said the test results weaken the government's hand. Since the assumption is that the economy is on the rebound, banks that don't need to sell assets to build capital are likely to hang on to them, thinking they are underpriced, and wait for the market to come back.
Some observers said regulators are most likely to force GMAC to participate but will have little leverage to persuade others to do so.

"It's possible that GMAC, which is likely to have some tough government supervision in its restructuring, will be forced to participate but then the question is, can you do a program like this with one participant on the sell side?" Low said. "And it just doesn't seem likely. What it comes down to is, how much does [Treasury Secretary Timothy] Geithner personally want this program to succeed because now that the economy is recovering it's hard to make the case that PPIP participation is in the best interest of shareholders."

But others argue that PPIP still makes sense. For one thing, many institutions other than the largest 19 could benefit, they said.

Mark Zandi, the chief economist and a co-founder of Moody's, said that PPIP would be an avenue for regional and community banks to shed assets.

"The stress tests were for only the top 19 bank holding companies, and there are a lot of other banks that would welcome the ability to sell assets if there was an avenue to do that in a reasonable way," he said.

He added that some of the largest banks may also find a benefit.

"If it works, it would reduce a lot of the uncertainly that still remains," he said. "The big banks have now raised capital consistent with lower valuations for the loans they hold, but there is still [a lot] of uncertainty and speculation about what those loans are really worth. I think it would be helpful if they at least had the opportunity or the avenue to sell those assets."

Karen Shaw Petrou, the managing partner of Federal Financial Analytics, said PPIP is still needed because the stress test parameters might guide regulators in examining the rest of the industry, too, putting pressure on banks beyond the top 19 to raise capital.

"It's important to think of this not just in the context of the 19 biggest banks but in the rest of the industry where there are significant capital strains and fewer capital market disposition options," she said.

Robert Hartheimer, a former FDIC director of resolutions and now a special adviser to Promontory Financial Group , agreed that the plan has "the potential to be life-saving to many community banks."

Still, concerns that go beyond the stress tests could mean the PPIP may not have much impact. Many observers said fear remains that Congress or the Treasury Department could impose additional restrictions on companies that participate in the PPIP. This fear is likely to make participation in the program something of a last resort, they said.

"I believe some banks will think very long and hard about whether there are other private-sector solutions to … some of their troubled-loan problems," said Hartheimer.

Petrou cited continuing concerns about potential conflicts of interest if banks can both buy and sell assets through the program.

"There are a lot of concerns about the program, some of which are valid, including the degree to which you can be on two sides of a PPIP transaction," she said. "The regulators should be addressing that."


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