6 of 19 Tested Banks Need to Raise Capital

According to a report late last night from Bloomberg, six of the nineteen banks that were stress tested by the Fed will need to raise additional capital.  Two of the six are known: Citi and BofA.*  Both are appealing the ruling.  The other four banks aren’t known, but SunTrust, KeyCorp and Regions Financial are believed to be among them according to a Morgan Stanley report cited in the article.  Given its poor tangible common equity ratio, and high exposure to option ARMs, HELOCs and California in general, Wells Fargo should certainly be included.

It’s unfortunate, but the whole exercise still feels like an excuse to direct additional taxpayer dollars to “systemically important” financials.

There were hopes that stress tests would force a proper resolution of troubled bank balance sheets.  It would discover which banks truly need more capital and then force them to raise it properly, by wiping out shareholders and executing debt for equity swaps in order to reduce liabilities and rebuild equity.

But this was never a serious exercise.  For starters, the “scenarios” by which balance sheets are being tested are far too rosy.  House prices are falling faster, unemployment is climbing higher, and growth is decelerating quicker than the Fed and Treasury would like to admit.  But this is inconvenient.  Properly stressing the big banks’ balance sheets would demonstrate that most are insolvent.  And insolvency can’t be solved with an extra hit of taxpayer cash.  But if government can paper over losses long enough, it can continue the charade that this is all a temporary liquidity problem.  Just one more fix of taxpayer cash can get banks through the crisis.

But after TARP, FDIC’s TLGP, half a dozen new lending facilities from the Fed, a second round of TARP injections, taxpayer guarantees to absorb losses at Citi and BofA, etc., no one buys the argument that the banks will be fine if they get just a little more help…

Now the administration will claim taxpayers aren’t supposed to provide additional capital this time around, that banks should go to private markets first and/or convert preferred to common before asking Treasury for more.  But this is just misdirection.  Private capital markets know that banks are insolvent, so they aren’t going to provide additional capital.  As for converting preferred to common, yeah that will boost TCE, but it doesn’t actually ADD any capital to banks’ balance sheets.  67¢ cents of preferred equity + 33¢ of common equity = $1 of total shareholder equity.  Convert all the preferred to common and you still have only a $1 of total equity.  There’s no extra capital on the balance sheet to absorb losses.

This leaves taxpayers as the only source of incremental equity capital.  Count on Wunderkind Geithner to find clever ways to deliver more of it to his buddies.

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*According to a report from FBR, BofA needs to raise $60-$70 billion

FAIR DISCLOSURE: OA has short positions in companies mentioned in this post.

Posted in banking, Fed, taxpayer issues, treasury, Wall Street |