Stress Test May Push 14 Banks to Raise Money, FBR’s Miller Says

U.S. Regulators may compel as many as 14 of the nation’s 19 largest banks to raise common equity based on financial stress tests due to be completed next week, said Paul Miller, an analyst at FBR Capital Markets Corp.

Miller, a former bank examiner, said his estimate assumes regulators will require banks to maintain tangible common equity, one of the most conservative measures of capital, equal to 4 percent of their risk-weighted assets over the next two years, to withstand losses in case the recession worsens. The tests, originally scheduled for release on May 4, are set to be disclosed after U.S. markets close on May 7, according to a government official who spoke on condition of anonymity.

Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc. and the 16 other banks received preliminary results last week and have been debating the findings with regulators. Officials favor tangible common equity of about 4 percent of a bank’s assets and so-called Tier 1 capital worth about 6 percent, people familiar with the tests say. Tangible common equity, or TCE, is a gauge of financial strength that excludes intangibles such as trademarks that can’t be used to make payments. Tier 1 capital is a broader measure monitored by regulators.

“When you start talking about 4 percent on risk-weighted assets based on the stress test two years out, most banks will be required to raise more capital,” Miller said in an interview yesterday. “I believe it will be as high as 14.” He declined to name them.

Citigroup, which has already taken $45 billion in U.S. taxpayer funds to shore up its finances, may need to raise as much as $10 billion in new capital, the Wall Street Journal reported today, citing people familiar with the matter. Jon Diat, a spokesman for the New York-based bank, declined to comment.

Trone Picks Four

Miller, 47, is a former examiner for the Federal Reserve Bank of Philadelphia and was the top-ranked stock picker among bearish analysts evaluated by Bloomberg Markets magazine last year. He’s based in Arlington, Virginia.

Miller’s views aren’t shared by all of his peers. David Trone, who covers 13 of the 19 lenders at Fox-Pitt Kelton Cochran Caronia Waller in New York, said his math shows that only four of the banks he focuses on will need more capital because of the stress test. Trone’s team upgraded the U.S. banks to “marketweight” from “underweight” this week.

The four are Regions Financial Corp., SunTrust Banks Inc., PNC Financial Services Group Inc. and Wells Fargo & Co., Trone said. He estimates that PNC Financial needs $1.9 billion, Regions Financial requires $1 billion and Wells Fargo has to line up $1.5 billion. SunTrust needs $400 million, he said.

Government’s Preferred Stock

He added that, while his calculations don’t show a need for Citigroup and Bank of America to increase common equity, it’s possible the government is using different assumptions and will require them to do so.

Miller and his team expect the banks will be encouraged to convert preferred stock held by private investors into common stock before converting preferred stock purchased by the government as part of the Troubled Asset Relief Program.

It’s possible the government will forfeit dividends on its preferred stock to enable the banks to suspend payouts on trust preferred securities, known as TRUPS, that are held by private investors and encourage those investors to convert into common stock as well, Miller said.

“You couldn’t pay the TARP dividend and cut the TRUP dividend, you’d have to cut them both, so the government could do that, the government could allow that to happen,” he said. “And frankly we’ve argued that you’re bleeding capital away from these banks that need it by making the banks pay these dividends and that they should waive all these dividends.”

Conversion

By contrast, Trone said he doesn’t think the government should encourage the banks to exchange privately owned preferred stock and dilute common shareholders in anticipation of potential future losses.

Instead he said the government should help the banks that may need more common equity by converting the government’s preferred stock into a new class of so-called convertible preferred securities, which could be turned into common stock as required.

“Converts could provide you contingent common in the amount needed,” Trone said. “A lot of these companies could end up doing better than we expect. This is supposed to be the worst-case scenario.”

The 19 firms include Goldman Sachs Group Inc., GMAC LLC, MetLife Inc. and regional lenders, including Fifth Third Bancorp and Regions Financial.

The banks in the tests hold two-thirds of the assets and more than one-half of the loans in the U.S. banking system, according to a Fed study released April 24.

Firm-Specific Details

The delay in releasing the stress-test information follows an internal debate among regulators about how best to reveal to markets the health of the biggest banks, which is usually reserved for bank examiners.

The government will disclose both aggregate information about the capital buffer required to absorb losses if the recession worsens and firm-specific details, the government official said yesterday. The details may help investors distinguish strong from weak banks, leaving the latter to turn to the government for capital.