Banks Explode on a $65 Billion Landmine

So much for secrecy.

The banks' stress test results, meant to remain secret until later this afternoon, have been leaked almost in their entirety. At least seven of the 19 banks subjected to the forward-looking test will be required to bolster their capital by a combined $65 billion.

Again, these results aren't official, but here's what has been leaked so far, according to the Wall Street Journal.

Bank

Capital Shortfall

Bank of America (NYSE: BAC  )

$34 billion

Citigroup (NYSE: C  )

$5 billion

Wells Fargo (NYSE: WFC  )

$13 billion-$15 billion

Morgan Stanley (NYSE: MS  )

$1.5 billion

GMAC

$11.5 billion

Regions Financial

Unknown

State Street

Unknown

Source: The Wall Street Journal.

Word also trickled out that JPMorgan Chase (NYSE: JPM  ) , Goldman Sachs (NYSE: GS  ) , and American Express (NYSE: AXP  ) , among others, passed the test and will be let off scot-free.

Once the results are officially disclosed later today, the banks with capital holes will be given one month to present a plan on how they'll raise the money. They'll then have six months to actually get it done.

How can banks raise capital? They have a few different options:

  • Sell assets
  • Raise money from private investors
  • Convert preferred shares into common capital

The first, selling assets, is simply much easier said than done. For banks required to raise a relatively small amount of money, it's feasible. But for others, it'll either be impossible or extremely inefficient. If beleaguered banks could sell a meaningful amount of assets at levels that didn't constitute giving away the house, they'd already be doing so. Not unlike the issues clogging the broader debt markets, banks will be constrained in selling assets, because there are either no buyers for them, or they could only fetch wildly unimpressive prices in today's market.

This leaves the second two options -- raising money from private investors, or getting it from Uncle Sam -- as the most probable. Now that bank stocks have gone gangbusters over the past eight weeks, tapping the private markets might actually be manageable. Raising money from private markets is obviously preferable to asking Washington for help. Private investors rarely demand Congressional hearings to ask how the money's being spent, and they don't have the power to slap together 90% retroactive taxes when they get annoyed.

That said, we have yet to determines whether the ferocious rally that's sent some bank stocks up several hundred percent is really sustainable. I happen to feel it isn't.

Take Bank of America. Shares soared 17% yesterday -- and another 19% at one point this morning -- on news that it has a capital shortfall equal to more than one-third of its market cap. Some investors will tell you "the uncertainty of how much capital will need to be raised is gone." OK, but now we know what the "certainty" is: It's terrible, and potentially disastrously dilutive. That's reason to send shares back up to where they were before January's bailout?

Besides, where will the $34 billion come from? If the capital comes from preferred stock conversions, what will the conversion price be? How dilutive will that become? No one knows the answers to these questions, but investors seem assured that when the answers come, they'll work out in Wall Street's favor. That's a dangerous place to be.

At any rate, we'll have continuing coverage of the bank stress test results as the info rolls in. Tomorrow morning, we'll have a Fool roundtable discussing the pros and cons of the data, and what it means for your investments going forward.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. American Express is a Motley Fool Inside Value recommendation. The Fool owns shares of American Express, and has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 07, 2009, at 3:42 PM, dlpfrench wrote:

    Do you guys actually know anything. you might want to change your name to Motley Clueless. You are just passing on inaccurate crap info. Especially on BAC...when Citicorp should be indicted for fraud. Do you all actually do any work?

  • Report this Comment On May 07, 2009, at 4:21 PM, Seano67 wrote:

    Dipfrench, what exactly are you taking issue with in the article? It all seems very logical and factual to me, however if you have a disagreement, it would be helpful if you could point out exactly what it is you're disagreeing with.

  • Report this Comment On May 07, 2009, at 4:40 PM, dobbinst wrote:

    WSJ reported State Street does NOT have a capital shortfall.

  • Report this Comment On May 07, 2009, at 4:43 PM, TMFHousel wrote:

    dobbinst,

    WSJ changed its report after this article was published.

    From this morning's WSJ report: "Also in need of more capital: Regions Financial Corp. and State Street Corp."

    -Morgan

  • Report this Comment On May 07, 2009, at 5:25 PM, BellasPosting wrote:

    The shorts will print anything to get the bank stocks to fall...

  • Report this Comment On May 07, 2009, at 5:38 PM, Ibeatmykids wrote:

    I have noticed alot of comments such as dipfrench's lately. If there is a point you would like to make go ahead and make it but don't just hurl insults because it is annoying reading worthless comments.

    That being said, I have officially changed from a bull to a bear. The market will start going down soon since this rally was actually just a bounce based on nothing but simple physics of the market htting the bottom..

  • Report this Comment On May 07, 2009, at 5:39 PM, Ibeatmykids wrote:

    I don't think they want the banks to fail but lets be real, the banks are in need of billions of dollars. Should we all celebrate and keep buying?

  • Report this Comment On May 07, 2009, at 6:59 PM, ozzfan1317 wrote:

    Even if its just a short term bounce If you can stomach short term loss alot of very good companys are very attractively priced right now. Citi is a lost and Bank of America will most likely end up worthless too. I am glad I stayed away from the financial sector other than the top couple of companys its a dangerous place to put your money.

  • Report this Comment On May 07, 2009, at 6:59 PM, bearlyinvesting wrote:

    True the banks have to raise substantial capital to satisfy government pundits who forsee a substantial period of recession, unenployment, and credit defaults. However, the economy has bottomed out and better times lie ahead. I suspect that the defaults, and associated bank losses will not be nearly as bad as predicted. The banks may have to raise reserves, but will not necessarily suffer the losses envisioned by uncle sam. Private equity will most likely provide adequate capital, and though share price may suffer in the short haul, long-term prospects look good. I'm buying and will buy more if price falls.

  • Report this Comment On May 07, 2009, at 7:00 PM, ozzfan1317 wrote:

    The Only financial companys worth your money in my Opinion are GS,WF And AXP.

  • Report this Comment On May 07, 2009, at 8:25 PM, XMFRael wrote:

    Disclosure: i sold half my IRA BAC this morning (bought at 8 -- sold at 14-something). Still hold a good bit.

    Why sell? Frankly, I'm scared of the govt. and all the yapping -- including this site, which baffles me.

    It all seems so... irrational and foundless.

    Question: At what point will you let this go?

    If only to have my old BAC before the govt. got its hooks in (MER). Though if it turns out Lewis stepped up to "save the financial system" I'll gladly pay my share...

    (And yes, I'll accept countrywide, too. Which is just good old business. Where you win some, lose some).

  • Report this Comment On May 07, 2009, at 8:59 PM, StopLaughing wrote:

    It could be that the banks such as BAC will raise capital by selling toxic mortgage assets to the government. That lowers their need for capital at the same time it may raise some capital. The government has money set aside to buy toxins for more than they are worth.

    The stress tests may be political cover for buying the toxic assets for more than they are worth. With PPIP the toxins can be moved to the banks that don't need capital (kind of insane, but this whole idea was a Goldman idea).

    On the other hand WFC has indicated they will sell new stock (at least some). They have a boat load of toxins but they (and most banks) want to keep the toxic assets since mark to market is no longer killing them.

  • Report this Comment On May 07, 2009, at 10:06 PM, KnightTrader4u wrote:

    BAC -- is dead in the water.

  • Report this Comment On May 07, 2009, at 11:32 PM, catoismymotor wrote:

    My cat just french kissed my dog. Even though I do not understand why it happened it does not mean that I would have paid money to see it. Likewise I would not pay money to buy stock in a bank that needs to raise tens of billions of dollars in order to stay afloat. I can watch the freak show for free.

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