chance the market reaction will be restrained if Treasury makes it clear the stress tests are only designed to determine and fill capital holes

TO BE NOTED: From Reuters:

1 of 1Full Size

By Karey Wutkowski - Analysis

WASHINGTON (Reuters) - The Obama administration faces one of its most sensitive financial decisions yet -- how to release the results of stress tests on the 19 largest U.S. banks without sending the weaker ones into a tailspin.

Intense investor interest and a desire among stronger banks to leak their results to differentiate themselves from rivals has caused regulators to abandon any hope of keeping the results under wraps.

The latest government plan is to release some form of the results in May and experts say Washington needs to be able to offer a clear message about how it will deal with weaker banks without risking the collapse of those institutions.

"The problem is that by putting somebody's name out there as being weak, the likelihood of having a run (on a bank) is pretty substantial." said Gil Schwartz, a former lawyer at the Federal Reserve who now works in private practice.

The tests were announced in February as a seemingly straightforward assessment of what additional capital banks would need if the economy deteriorates further.

Although the U.S. Treasury has said the tests are not pass/fail, the fear is that the markets will view institutions requiring more capital as failing.

Banks found to need more capital are meant to have six months to raise the funds in the market or seek an immediate government capital infusion.

Questions linger about whether regulators will go further than capital injections and other already announced plans to purchase toxic asset off banks' balance sheets.

For example, it is not clear if regulators will insist upon management changes, asset sales, mergers or large government ownership stakes.

And the government has asked Congress for more power to wind down troubled firms through a "resolution authority," fueling speculation about the fate of banks deemed weak.

"God help us if we get resolution authority and we think that some banks are going into the hospital and they end up going into the mortuary," a source active in the bank industry said, speaking anonymously because he is close to the top banks being tested.

TEST RESULTS

White House spokesman Robert Gibbs said on Wednesday that the government will release "in a systematic and orderly way... some of the results of these stress tests" in early May.

Gibbs said the stress test process was designed to give an exact diagnosis of the problem at the top banks, and should be seen as a step toward stability in the financial system.

"I think, rather than these being seen as a destabilizing activity, that instead they will be seen as... a stabilizing activity, that our hope is that banks that are not healthy or need help will, first and foremost, seek that help privately, and then we'll take steps from there to assist them," he said.

Some experts say there may not be that many banks that will be deemed to have a capital need under the more adverse economic conditions being tested.

"The universe of banks that will fail will probably be small. I would think there would be at least one casualty, but that will probably be someone whose share price is already low," said Bob Stovall, strategist at Wood Asset Management in Sarasota, Florida, which has more than $1 billion of assets under management.

The government is leaning toward disclosing industry-wide results of the stress tests, and then allowing banks to reveal their individual results in some coordinated fashion, according to sources familiar with top policymaker talks.

The source close to the top banks said regulators jeopardized the chances of an orderly disclosure when it decided to release the test results after the banks' first-quarter earnings season.

Wells Fargo and Goldman Sachs revealed strong first-quarter results in recent days. Goldman further tried to distance itself from weaker banks by laying out a plan to return $10 billion in government bailout funds by raising private capital.

With some banks touting their strength, it raises the market's appetite for information, and could put weaker firms on the defensive during the stress test disclosures.

For example, the bank industry source said, a weaker bank could announce that the Federal Reserve says it needs a $12 billion capital infusion, but also say it disagrees with the assessment, casting doubt on the test result.

"There's obviously a risk of it being handled badly if there's uncertainty or ambiguity (about the results)," this source said.

But there is also a chance the market reaction will be restrained if Treasury makes it clear the stress tests are only designed to determine and fill capital holes. "I think there's a possibility that if they stick with what they originally proposed, it will not be chaotic," the source said.

(Reporting by Karey Wutkowski with additional reporting by Dan Wilchins and John Poirier; Editing by Tim Dobbyn)"