Citi and Bank of America "Encouraged" to Get More Capital

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Citi and Bank of America "Encouraged" to Get More Capital as Result of Stress Tests

Recall many observers, including yours truly, deemed the Team Obama stress tests to be more than a tad permissive, The 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 made that the interpretation of the results would be more stringent in light of worsening economic conditions, so perhaps they did recalibrate their grades.

From the Wall Street Journal:

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....The two banks are planning to respond with detailed rebuttals, these people said, with Bank of America's appeal expected by Tuesday.

The findings suggest that government officials are using the stress tests to send a tough message to struggling banks. Bank of America and Citigroup have been the highest-profile problem children in recent months, but it is unlikely that they are the only banks the Federal Reserve has determined might need more capital.

Industry analysts and investors predict that some regional banks, especially those with big portfolios of commercial real-estate loans, likely fared poorly on the stress tests. Analysts consider Regions Financial Corp., Fifth Third Bancorp and Wells Fargo & Co. to be among the leading contenders for more capital....

Government officials say their meetings about the stress tests with bank executives over the past few days conveyed preliminary results and that discussions were expected to continue this week about specific findings. They also say that banks directed to raise more capital shouldn't be viewed as insolvent.

Instead, the capital is intended to cushion the banks against potential future losses under dire economic conditions. Federal officials say they won't allow any of the top 19 banks to fail.

Still, it is unclear how flexible the government will be about adjusting the results, especially as banks plead their cases individually. Banks have until the middle of this week to lodge their formal responses to the tests. Bankers expect that will set the stage for several days of intense negotiations between the banks and their examiners....

Bank of America's capital hole as measured by the regulators is in the billions...It isn't clear how big a capital deficit Citigroup faces....

Raising capital in the current environment is nearly impossible for troubled financial institutions...

Some bank executives have said that even after meeting with Fed examiners on Friday, they still don't understand details of the government's methodology for conducting the tests...

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.

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