June 1 (Bloomberg) -- The 19 largest U.S. banks will have to demonstrate they can sell new shares before they are allowed to repay their government stakes, the Federal Reserve Board said today.

The companies “must successfully demonstrate access to public equity markets,” the Fed said in a statement released today in Washington. They also need to sell debt without a Federal Deposit Insurance Corp. guarantee and reduce reliance on “government capital” and the FDIC’s program.

The conditions reflect an attempt to ensure the nation’s largest lenders are strong enough to stand on their own before retiring the government’s stakes. Wall Street firms that took taxpayer assistance in the depth of the crisis last year are now seeking an exit from the Troubled Asset Relief Program after lawmakers sought conditions including executive pay limits.

With the U.S. unemployment rate forecast to surpass 9 percent this quarter and losses expected to mount on commercial property, some analysts said the danger is that banks rush to repay TARP funds before the financial system has completely stabilized.

“I would probably make them wait a few quarters,” said Joel Conn, president of Lakeshore Capital in Birmingham, Alabama, which manages about $100 million. “Having them come back” to the government for aid again “is the nightmare scenario.”

Commercial Property

Standard & Poor’s analysts led by Kevin Ahern said in a statement last month that “as the recession rolls on, we believe that there is an increasing possibility of distress for commercial real estate owners and for those that hold their mortgages.”

Banks selling bonds without U.S. government backing are borrowing at unprofitably high interest rates to demonstrate they can access capital markets, Barclays Capital analysts led by Jonathan Glionna wrote in a May 29 report.

JPMorgan Chase & Co., the sole major bank lobbying to repay TARP that has yet to issue new equity this year, said after the Fed release that it will raise $5 billion in common equity to satisfy regulators’ conditions. American Express Co. also said today that it plans to raise $500 million in common stock to help fund the repayment of government shares.

Biggest Reimbursement

JPMorgan, Goldman Sachs Group Inc. and Morgan Stanley have applied to refund a combined $45 billion of government investments, a step that would mark the biggest reimbursement to taxpayers since the $700 billion bank bailout program began in October.

“Having the big guys pay TARP money back makes additional money available to lots of smaller banks that may not be able to raise new capital,” said Joel Conn, president of Lakeshore Capital in Birmingham, Alabama, which manages about $100 million, with about 9 percent in financial stocks. “This helps replenish the kitty.”

An announcement on the “initial set” of redemption approvals will come during the week of June 8, the central bank said. Applications to repay TARP money will be evaluated “periodically thereafter,” according to the statement.

Nine of the 19 largest banks that were subjected to regulators’ stress tests were judged on May 7 to have no new need for additional capital. Ten of them were deemed to require a total of $74.6 billion in additional reserves to guard against the risk of a more severe economic downturn.

Fill Shortfalls

The list of 10 included Bank of America Corp., with a shortfall of $33.9 billion, Citigroup Inc. with $5.5 billion, and Wells Fargo & Co. with $13.7 billion. The firms were given a one-month deadline to produce a plan to fill the shortfalls, and six months to execute their proposals. The Fed’s statement today didn’t address how or whether regulators will announce their pronouncements on those submissions.

Since the release of the stress test results, Bank of America, Fifth Third Bancorp, Morgan Stanley and others with a capital-buffer requirement have announced plans or already raised about 40 percent of the equity for the $74.6 billion, according to data compiled by Bloomberg News on May 18.

The KBW Bank Index has doubled since the March 6 low on signs of possible recovery in the U.S. economy. Still, Fed officials forecast that unemployment will linger at high rates of just above 9 percent through the end of next year, showing little improvement from the April rate of 8.9 percent.

The nine banks that have no capital buffer requirement include American Express Co., BB&T Corp., Bank of New York Mellon Corp., Capital One Financial Corp., Goldman Sachs, JPMorgan, MetLife Inc., State Street Corp., and U.S. Bancorp. These firms have announced or raised a combined $23.3 billion through debt or equity sales to help fund TARP repayment, according to data compiled by Bloomberg News May 18.

Banks will have to demonstrate how they will meet funding requirements and obligations to counterparties while reducing reliance on government capital and the debt guarantees, the Fed also said today.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net.

Last Updated: June 1, 2009 18:25 EDT