The Treasury's "stress tests" are now complete, and the results are in the hands of the banks' CEOs. While investors have to wait until May 4 to see the official results, whispers, suspicions, and leaks are already flooding the marketplace.
One leak, reported by CNBC, warns that "At least one firm, under the stress test assumptions, will require more capital."
And here lies the catalyst that might crash the recent bank stock bonanza: Some big banks are going to be forced to double down on capital, and those that do are going to take a pants-down spanking from shareholders crushed by share dilutions. As Warren Buffett -- who sounded somewhat bullish on banks last month -- warned, "The only worry in that is the government will force [banks] to sell shares at some terribly low price." Worry, meet reality.
So, who might be forced to recapitalize? Looking at tangible common equity -- one metric the stress test centers on -- a few stick out:
|
Bank |
Tangible Common Equity |
|---|---|
|
Citigroup |
1.5%* |
|
Bank of America |
3.13% |
|
Wells Fargo |
3.28% |
|
JPMorgan Chase |
4.3% |
|
Goldman Sachs |
4.5% |
|
Morgan Stanley |
4.3% |
*Prior to pending government share conversion.
Citigroup is an obvious outlier. To counter its near-fatal capitalization, the bank announced plans earlier this year to convert tens of billions of dollars worth of preferred stock into common equity -- a move that will recapitalize its common equity capital, albeit by diluting current investors by as much as 74% when the conversion takes place.
Even so, the Financial Times reports that Big C could need more capital even after the upcoming conversion. If that ends up being true, and they are unable to raise private capital, you're effectively staring at nationalization. Current investors will own just 26% of the company after the already-announced conversion -- another government capital injection would dilute shareholders into an almost infinitesimal significance.
So, is Citigroup the one and only bank that might be forced to double down? Don't count on it. Bank of America and Wells Fargo look vulnerable, too. CNBC reports that banks might be required to hold 3% tangible common equity after a worst-case scenario plays out. That's disheartening because both are already flirting with 3% tangible common equity as it is.
Announcing gargantuan losses was the first leg of dealing with bank fallout. Raising capital by issuing stock at depressed levels is the next step, and one that may prove just as nightmarish for investors.
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