We have had the methodology (sort of), now we are starting to get some early leaks results from the US bank stress tests.
And on the face of it they do not look so good for either Bank of America or Citigroup.
From the Wall Street Journal’s Tuesday report (our emphasis throughout):
Regulators have told Bank of America Corp. and Citigroup Inc. that the banks may need to raise more capital based on early results of the government’s so-called stress tests of lenders, according to people familiar with the situation.
The capital shortfall amounts to billions of dollars at Bank of America, based in Charlotte, N.C., people familiar with the bank said.
Executives at both banks are objecting to the preliminary findings, which emerged from the government’s scrutiny of 19 large financial institutions. The two banks are planning to respond with detailed rebuttals, these people said, with Bank of America’s appeal expected by Tuesday.
In fact, Citi has already started spinning:
Citigroup wants to get credit for its recent efforts to shrink its balance sheet by selling businesses such as Smith Barney and its Japanese brokerage arm, say people familiar with the matter. While those deals haven’t yet been completed, they’re expected to ultimately give a significant boost to Citigroup’s capital levels.
In addition, Citigroup executives have concerns about some of the assumptions the Fed used in calculating the timing and severity of future losses on consumer loans such as credit cards, according to one person familiar with the matter.
Mind you, the below is probably pushing things too far.
One question is how the government is projecting banks’ revenue streams through 2010. Some bankers are optimistic that the Fed will use their first-quarter numbers to predict their performance for the next two years. That could inflate the banks’ earning potentials — and thus their capital cushions — because many of the companies had strong first-quarter performances. Analysts, investors and most executives say those results probably aren’t sustainable.
Quite!
Of course, one could ask just how much of surprise is this? After all, most bank watchers expect BoA and Citi to raise more dosh. For example, here’s Deutsche Bank’s new financials analyst, Matt O’Conner, starting coverage of BoA on Wednesday:
BAC shares are already pricing in a large common equity raise (the stock trades at less than 2x our normalized EPS est. before adjusting for a capital raise)–so the key question is how much will they need, where do they get it from and at what price. Under our stress test, we est. tangible common equity to risk adjusted assets of 1.8%. Since we believe regulators may target at least 3%, this implies a large capital raise is possible in the near term. This would likely pressure the stock, as it’s unclear to us whether BAC will be able to raise capital without gov’t help.
But all that misses the point. If Citi and BoA are required to secure some more equity, most probably from the US taxpayer, then the tests can at least be presented as credible, as Yves Smith at Naked Capitalism notes.
Recall many observers, including yours truly, deemed the Team Obama stress tests to be more than a tad permissive. Their supposed downside scenario is coming to look more and more like a middle of the road outcome. Moreover, the banks ran the tests themselves (!) using their own pricing and risk models, and the focus was on loans, when many types of structured credits are more sensitive to increasing default rates.
But even with these industry-coddling approaches, Citi and BofA, both of which have large securities operations, appear to be coming up a tad short. This is either a sign that they are in as bad shape as we suspected (ie, even with the lax stress tests they didn’t look too hot) or the criticism of the tests made the powers that be realize that giving the big banks a pass, particularly if they were to get in trouble not too far down the road (as in the next year) would completely undermine the Treasury’s credibility. Treasury said that the interpretation of the results would be more stringent in light of worsening economic conditions, so perhaps they did recalibrate their grades.
Related links:
DIY stress test – FT Alphaville
Statement: Fed Releases More Stress Test Methodology Details – FT Alphaville