The Malaysian Insider

NEW YORK, May 7 — Citigroup Inc and Bank of America Corp shares rallied today ahead of “stress test” results that will force top banks to raise billions of dollars in capital and draw a line between the weak and the strong.

The hotly anticipated release of the test results are the culmination of a months-long exercise aimed at tackling one of the thorniest problems of the US financial crisis: how to revive top banks and get credit flowing again.

“What this does is that it begins to give investors some clarity that we are starting to separate the wheat from the chaff. We know who’s performing well and is potentially able to buy their way out of TARP, and who still needs a little bit of help and a little more restructuring,” said Phil Orlando, chief equity market strategist at Federated Investors in New York, speaking yesterday.

The results of government stress tests of the ability of the 19 largest US banks to weather a deep recession were to be released at 5pm EDT today (5am, Malaysian time on Friday) and were expected to show about half the banks need more capital.

Federal Reserve Chairman Ben Bernanke today described the tests as a fair and comprehensive effort that he said should allow markets to have greater confidence in the condition of the top US banks.

US Treasury Secretary Timothy Geithner, who along with other top regulators will brief the media on the test results, said in an opinion piece in The New York Times that he expects banks will pay back more than the US$25 billion (90 billion) of government rescue funds that he had previously estimated.

Geithner also wrote that the stress tests applied “exacting” loss estimates and conservative earnings estimates, an apparent rebuff to critics who have questioned whether the tests were tough enough.

The relatively positive news on the banks was a welcome development for US President Barack Obama, who is under pressure to show that his steps aimed at rebuilding the US economy will bear fruit.

His team appeared to manage market expectations well, getting the worst news from the stress tests out two days ago – that Bank of America needs as much as US$34 billion in additional capital.

“I think things feel a little better,” Treasury Secretary Timothy Geithner told PBS’ “The Charlie Rose Show” yesterday. “I think people sense a bit more stability. And you can see it in behavior. People are spending a bit more. Investors, companies are starting to borrow again so they can start to make investments again.”

But skeptics still abound.

“Although there are signs of economic improvement, they are not yet strong enough to suggest that the banking industry will not need significant capital in addition to the Treasury-announced capital requirements,” analysts at Keefe, Bruyette and Woods wrote in a note to clients.

While the capital shortfalls reported so far are much larger than analysts had expected, bank shares have been soaring as investors get more clarity over how well the industry will cope with perhaps the most severe recession since World War Two.

Among banks needing capital, Bank of America shares were up 15 per cent in morning trading on the New York Stock Exchange, Citigroup rose 3.9 per cent, while Wells Fargo & Co fell 3.0 per cent. The sectoral KBW Banks index was up 1.8 per cent.

Debt protection costs for several major financial institutions, including Citigroup and Morgan Stanley, fell Thursday morning following the reports on stress test results.

Regulators have told Bank of America it needs US$34 billion, while Citigroup needs US$5 billion and auto and mortgage lender GMAC LLC needs US$11.5 billion, according to sources familiar with the matter.

Bank of America shares were boosted by two analyst upgrades, by Stifel Nicolaus and Robert W. Baird & Co, with the latter calling the largest US bank’s capital needs “manageable.”

Citigroup’s capital needs reflect its previously announced plan to convert some preferred shares into common stock.

Wells Fargo needs US$15 billion, Morgan Stanley needs US$1.5 billion, and Regions Financial Corp needs some capital, The Wall Street Journal said.

Bank of New York Mellon Corp does not need capital, a person familiar with the matter said.

American Express Co, Capital One Financial Corp, Goldman Sachs Group Inc, JPMorgan Chase & Co and MetLife Inc also do not need capital, the Journal said.

All the companies declined to comment.

The various sources reporting the stress test results were not authorised to speak because the results are not yet public.

STABILITY SOUGHT

Banks may cover any capital shortfalls through a mixture of asset sales, share sales and perhaps the conversion of preferred shares into common stock.

The government is giving banks needing capital one month to develop a plan to raise it, and until November 9 to finish the job. These banks must also review their management and boards of directors to ensure proper leadership.

Banks needing capital may ask to swap government preferred shares into “mandatory convertible preferred” shares, which allow the government to take equity stakes only as needed.

The banks cannot repay aid from the Troubled Asset Relief Program (TARP) until they issue debt not backed by the federal government, and for more than a five-year term.

If banks convert preferred shares issued under TARP, the government could become one of their biggest shareholders. The White House said it would await the stress test results before commenting on banks’ potential management changes.

Analysts at Goldman Sachs estimated that banks’ capital needs after the stress test would total US$130 billion, with US$100 billion needed by weak banks to plug holes and US$30 billion needed by stronger banks to repay TARP funds.

Analysts believe other banks that may need capital include Fifth Third Bancorp, KeyCorp, PNC Financial Services Group Inc and SunTrust Banks Inc. – Reuters