Results of the bank stress tests are out -- unofficially -- for Bank of America (NYSE:BAC) and Citigroup (NYSE:C). The Wall Street Journal reported today that the government's preliminary results indicate that both banks have capital shortfalls that need to be stopped up by raising common equity levels. Both institutions are preparing rebuttals and will enter negotiations with the government to determine the next course of action. Bank stock investors should be paying close attention; the government is expected to release its results publicly next week.

The top 10
The following table contains the 10 largest U.S. bank holding companies by assets (excluding those controlled by foreign institutions), ranked by their tangible common equity (TCE) ratio:

Bank

Tangible Common Equity Ratio (as of March 31, 2009, unless otherwise noted)

SunTrust Banks

5.8%

Goldman Sachs (NYSE:GS)

4.6%* (March 27, 2009)

Morgan Stanley (NYSE:MS)

4.3%

JPMorgan Chase (NYSE:JPM)

4.3%

Bank of New York Mellon

4.2%

US Bancorp (NYSE:USB)

3.7%

Wells Fargo (NYSE:WFC)

3.3%

PNC

3.3%

Bank of America (NYSE:BAC)

3.1%

Citigroup (NYSE:C)

3.0%** (Dec. 31, 2008)

*Estimated. **Prior to the common shares/preferred stock exchange.
Source: Standard & Poor's Capital IQ.

It's no surprise that the leaked results focus on B of A and Citi: Not only are they bringing up the rear in the TCE ranking, but they are two of the three largest banks in the U.S., with nearly $4 trillion in total assets between them at the end of 2008.

There will be others joining the party
B of A and Citi won't be alone from our table. I think it's highly probable that Wells Fargo (NYSE:WFC) and PNC will both be required to raise capital -- by one estimate, Wells has a $50 billion shortfall (There may be others still; the government is conducting stress tests on 19 banks).

For now, uncertainty over the stress tests has likely rung the death knell of the recent massive bank stock rally; the Financial Select Sector SPDR ETF has gained over 70% since March 9. As the results are made public, perhaps we'll see a bifurcated market develop as investors distinguish between those banks that pass the stress test with high marks and those that need to take remedial action.

Bigger picture
My greatest concern, however, is that the government will heavily water down its requirements after negotiations with the banks. Unfortunately, this would be consistent with the government's equivocations to date and would delay repairing the banking system -- one of the keystones of an economic recovery.

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