Stress Tests: Bank Of America, Citigroup Underfunded?

The Stress Tests conducted by the regulators on Bank of America (BAC) and Citigroup (C) revealed that these banks need more capital, according to a report in the Wall Street Journal this morning. The shortfall is estimated to be “billions of dollars,” for BAC, but the report did not pin down an amount for Citigroup.

Both these banks have already received $45 billion from TARP funds, and of late they have been claiming that they do not need additional help from the government. It is reported that both banks dispute the regulators’ assessment and are in discussions with the regulators. Final capital assessment will be announced by the government on May 4.

We are not surprised by the reports. Though 1Q09 results for both these banks were better than the estimates, we pointed out in our blogs: Citigroup: Any Reason to Cheer? and BAC Beats Median Consensus that the results mainly benefited from the accounting profits resulting from the widening of their credit spreads (worsening of credit worthiness).

While BAC recorded $2.2 billion in gains related to mark-to-market adjustments on Merrill Lynch structured notes as a result of credit spreads widening, in case of Citigroup, the gains recorded were 2.5 billion. BAC also had a pre-tax gain of $1.9 billion on the sale of China Construction Bank shares.

Further, the near zero funding costs and surge in refinancing due to record low mortgage rates and better revenues from fixed income trading helped the results. These conditions are not sustainable, as banks themselves have admitted.

On the other hand, the credit quality had deteriorated sharply, especially in the housing and credit card portfolios and further deterioration is expected in the coming quarters.

As a result of the losses, the capital levels (specially the Tangible Common Equity, which will be seen by the regulators as a measure of capital adequacy) had come down below comfortable levels for both these banks. So any meaningful capital assessment exercise would have revealed a need for further capital.

In addition to these two, there are speculations over Fifth Third (FITB), Regions Financial (RF) and Wells Fargo (WFC) found to be in need of more capital.

With the TARP bailout funds now left at approximately $100 billion, we are not sure whether the government will be able to provide enough capital to these banks without approaching Congress for more funds. Alternatively, the regulators may consider converting TARP-preferred capital to common equity (as is already being done in the case of Citigroup) or converting debt (bonds issued by them) to equity.

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Comment by Yasir Saeed, RY International, Cotton Socks Manufacturer

2009-04-29 03:14:28

We are not surprised by the reports….

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