Crisis Q&A: What If My Bank Fails The Stress Test?

Posted on Monday, April 4, 2011

The Federal Reserve stress test results come out Thursday. Early reports indicate that as many of the 19 large financial institutions surveyed may need to raise more capital to satisfy regulators that they can deal with the current economic challenges.
How should individuals view the stress test results?
What happens if I'm an investor in one of the banks that's being asked to raise more capital?
It depends. Many of the banks reportedly needing the most capital, such as Bank of America, Citigroup and Wells Fargo, have rallied sharply ahead of the official stress test results. But there is a possibility that these banks will need to issue more stock to raise the required capital, which could dilute shareholders and lower share values.
In addition, some banks may end up with greater government ownership stakes as the result of converting certain government holdings into regular shares. This ownership stake could crimp certain business activities, though it remains difficult to determine how active a shareholder the government will be.
What happens if I own preferred shares in one of those banks? Is there a safe harbor?
Barring something radical and not currently anticipated, such as a bankruptcy filing or nationalization, your preferred holdings should function as before. The banks may need to issue additional preferred shares or other forms of equity, but preferred shares already issued should not be affected.
I have an account at a bank that has come up short in the Federal Reserve stress test and needs to raise more capital. Should I be worried?
No. The stress tests do not affect the government savings insurance programs, administered by the Federal Deposit Insurance Corp. Under this program, all cash accounts at banks are insured up to $250,000 per account until the end of this year. This insurance policy won't be affected by stress test results.
I have a mortgage with a bank that has come up short in the Federal Reserve stress tests. Does this affect my mortgage?
It depends on your situation. The bank's health is less important than your own personal financial health. If you are in a position to make your mortgage payments, you needn't be concerned if your bank fails. Even if the bank that holds your mortgage gets in trouble or fails, your mortgage obligations will still be obligations, and some other bank or financial institution will pick up your mortgage from the failed bank. You will have to continue paying your mortgage, but the holder of your mortgage might change.
I have a credit card with a bank that has failed a Fed stress test, what does that mean for me?
Very little. As a credit card debtor, there are plenty of financial institutions that would happily pick up your debt if the bank that issued your credit card failed or ran into trouble. There's one caveat to this, however. Banks are badly in need of cash, so many have been raising interest rates and fees on credit cards. You should keep a careful eye on the bank that issues your credit card and fight any interest rate or fee hikes. This is especially true if your bank transfers your credit card to another bank for any reason.
My bank passed the Fed stress test. Does that mean everything's fine?
It may or may not be fine for your bank, but the answers to the previous questions apply. The government cash deposit insurance program applies to you, your mortgage probably won't move and you should keep a careful eye on the credit-card fees and interest rates your bank is charging.
If a bank has passed the Fed stress test, does that mean its stock is now a good investment?
Bank stocks remain very risky investments. Even if a bank passes the stress test, it still faces challenges from bad residential real estate loans and a challenging commercial real estate loan market. Passing a stress test does not make a bank a great investment.

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