Banks that require funding will have 30 days to present a capital-raising strategy to regulators and then six months to implement it.

It is unlikely that any of the banks will require any additional taxpayer money.

J.P. Morgan Chase & Co. (NYSE: JPM), Goldman Sachs Group Inc. (NYSE: GS), MetLife Inc. (NYSE: MET), American Express Co. (NYSE: AXP), Bank of New York Mellon Corp. (NYSE: BK), BB&T Corp. (NYSE: BBT), Capital One Financial Corp. (NYSE: COF), U.S. Bancorp (NYSE: USB), and State Street Corp. (NYSE: STT) are in the clear in terms of having adequate capital cushioning.

The following banks will be required to raise these assigned amounts of capital:

• Bank of America Corp. (NYSE: BAC): $34 billion.
• Wells Fargo & Co. (NYSE: WFC): $13.7 billion.
• GMAC LLC (NYSE: GMA): $11.5 billion.
• Citigroup Inc. (NYSE: C): $5.5 billion.
• Morgan Stanley (NYSE: MS): $1.8 billion.
• Fifth Third Bancorp (NASDAQ: FITB): $1.1 billion.
• KeyCorp (NYSE: KEY): $1.8 billion.
• PNC Financial Services (NYSE: PNC): $600 million.
• Regions Financial Corp. (NYSE: RF): $2.5 billion.
• SunTrust Banks Inc.( NYSE: STI): $2.2 billion.

The banks will have until June 8 to develop a plan to raise the required capital and until Nov. 9 to implement it. They may choose to raise the money in a variety of ways. They may sell assets, court private investment or convert the government’s existing preferred shares into common stock.

Citigroup has already announced plans to convert a portion of the government’s $45 billion stake into common stock, a move that will give the federal government a 36% stake in the company. Other regional banks – such as Fifth Third Bank or Regions Financial – could be forced to take similar actions, but are loath to do so, as most of the moves would be dilutive to existing shareholders.

Citigroup has agreed to sell Nikko Cordial Securities to Sumitomo Mitsui Financial Group (OTC: SMFJY) for about $5.5 billion. The deal, which is to be completed by Oct. 1, is expected to boost the bank’s Tier-1 capital ratio by approximately 27 basis points.

Morgan Stanley plans to close its capital gap by selling assets or stock to private investors, a person briefed on the plan told The New York Times. And Wells Fargo said late yesterday that it plans to sell $6 billion in new common stock in an effort to raise required capital.

While Bank of America has said it doesn’t agree with the Fed’s conclusions, the bank yesterday outlined its strategy to accommodate the government’s demands. BofA is exploring the sale of such business units as its First Republic private-banking unit and asset manager Columbia Management, The Wall Street Journal reported.

The sale of those businesses could raise a combined $4 billion, David Hendler of CreditSights Inc. told The Journal. BofA could also get about $8 billion for its partial stake in China Construction Bank Corp.

Beyond that BofA would have the options of converting the government’s existing $45 billion investment, or $33 billion in private preferred shares, into common stock.

The Fed wants bank-holding companies to achieve a Tier 1 risk-based ratio of at least 6%, and a Tier 1 Common risk-based ratio of at least 4% by the end of 2010. The goal is to get banks to the point where they are stable enough that they can borrow from private investors without a Federal Deposit Insurance Corp. (FDIC) guarantee, people familiar with the matter told Bloomberg News.

“Going forward, we just need banks to be able to issue debt without the FDIC backing – that’s the next stage for these bank names in terms of evaluating their health,” Mark Bronzo, a money manager at Security Global Investors LLC, which oversees $21 billion in Irvington, N.Y., told Bloomberg.

If the banks fail to meet capital requirements, the government will step in to provide the necessary funds. However, it’s unlikely that any more taxpayer money will be needed, as about $110 billion of the original $700 billion in Troubled Asset Relief Program (TARP) funding remains.

Wall Street’s Reaction

The Dow Jones Industrial Average closed down 102.43 points, or 1.2%, yesterday, with the Dow Jones U.S. Financial Services Index down 3.78%. However, Wall Street’s reaction to the tests won’t be fully realized until the market opens later today (Friday).

“I think this will be a confidence-instilling announcement,” Federal Deposit Insurance Corp. Chairman Sheila Bair told a Senate panel Wednesday. “There will be additional needs for capital buffers for some institutions, but I think there will be mechanisms to do that within the next six months.”

Treasury Secretary Timothy F. Geithner said in an interview with PBS television’s “The Charlie Rose Show” that all of the institutions tested already have “significant cushions” of capital and that Americans have every reason to be confident going forward.

“The results will be, on balance, reassuring,” Geithner said.

But some analysts are skeptical about what the bank stress tests actually achieved, or if their standards of evaluation were even valid in the first place. After all, the tests have occupied resources from both the federal government and the private sector for months, and have increased stock market volatility.

“The banks are healing themselves, and it could have been done a lot faster if government had gotten out of the way instead of parking the emergency equipment in the middle of the road,” Gary B. Townsend, a former banking regulator who now runs his own investment firm, told The New York Times.

Also, many bank employees, and even Elizabeth Warren, who chairs the Congressional Oversight Panel for TARP, have expressed concern that the tests weren’t stringent enough.

Last month, Warren gave rise to speculation that another stress test might be needed by the end of the year, after she called the adverse economic scenario employed by the Fed “disturbingly close” to current economic conditions.

In the Fed’s most pessimistic economic forecast, for example, the government projects the unemployment rate will climb to 10.3% in 2010. But unemployment already hit 8.5% in March and many economists are predicting that it rose to 8.9% in April. If that’s the case, it’s not hard to imagine the national jobless rate reaching double digits by the end of the year.

“The stress tests will make a terrific contribution if they are tough and transparent,” Warren said. “If they are not, they will be useless.”

Still, despite the test’s alleged failings, there is a hope that with more transparency and a greater buffer of equity, investor confidence will be restored.

“This is sending a message that the banks need more capital, but their losses are manageable and the system itself is solvent,” Kevin Fitzsimmons, an analyst at Sandler O’Neill told The Times. “Whether it sticks is something else.”

Source: Bank Stress Tests: The Results Are in; Now What?

Officials insist that neither Bank of America nor Citigroup should be viewed as insolvent, but people familiar with the situation told The Wall Street Journal that the capital shortfall amounts to billions of dollars at BofA. It is not clear how much of a shortfall Citigroup faces.

Analysts anticipate that some regional banks also will be required to raise more capital.

Banks that need more capital will have six months to accumulate the additional infusions by selling assets, selling more shares, or converting preferred government shares into common stock. If they are unable to build their capital through public and private sectors, the banks may again dip into taxpayer-funded government coffers.

Bank of America and Citigroup have received a combined $95 billion in taxpayer infusions, as well as hundreds of billions of dollars in government guarantees on bad, or “toxic,” assets.

The government may become Citi’s largest shareholder as soon as next month when the bank converts as much as $52 billion in preferred stock into common shares.

If the banks are forced to take on more government funding, top executives at both BofA and Citi could be forced to resign. Citigroup Chief Executive Officer Vikram Pandit and the bank’s board of directors faced the ire of shareholders at the company’s annual meeting last week. But even as tensions flared, efforts to oust the management fell flat, as 10 incoming members of the company’s board, some of whom have been in place for two decades, were affirmed by shareholder votes.

Top-tier executives at Bank of America may not be so fortunate. BofA shareholders today (Wednesday) will decide the fate of Chairman and CEO Kenneth Lewis. Lewis has come under fire for the company’s acquisition of Merrill Lynch & Co. Inc. (SQD) last year. Merrill Lynch lost $15.84 billion in the fourth quarter of 2008, contributing to a $1.79 billion loss at BofA and forcing the bank to seek out more government assistance.

“The same directors and management that entered the Merrill deal are still there, and we think they destroyed shareholder value on a permanent basis,” Jon Finger, whose Houston-based investment firm is urging votes against Lewis and lead director Temple Sloan, told the Charlotte Observer.

For his part, CEO Lewis testified before New York’s attorney general that Federal Reserve Chairman Ben S. Bernanke and former Treasury Secretary Henry M. Paulson Jr. pressured him to move ahead with the merger despite his reservations – while also keeping quiet about mounting losses at the crumbling investment bank.

“I can’t recall if he said, ‘We would remove the board and management if you called it [off],’ or if he said, ‘we would do it if you intended to.’ I don’t remember which one it was,” Lewis said, referring to a conversation he had with Paulson. “I said, ‘Hank, let’s de-escalate this for a while. Let me talk to our board.’”
Bank Stress Tests Called Into Question

Both Bank of America and Citigroup objected to the preliminary findings by the government. Citi, in particular, has expressed frustration with the investigation into its finances.

The regulators are asking “a million questions” and it’s “very unclear what they’re aiming at,” a senior executive told The Journal. “We can’t discern a pattern.”

Executives who met with regulators at the New York Federal Reserve headquarters on Friday, when the banks were first made aware that they would probably be asked to raise more capital, say they still don’t understand the government’s methodology.

The Journal cited people familiar with the matter as saying Citi wants to get credit for its recent effort to unload such businesses as Smith Barney and Nikko Cordial Services, the bank’s Japanese brokerage arm. While these businesses have not yet been offloaded, they’re expected to boost Citigroup’s capital levels.

Citi also has concerns about the assumptions used by the Fed in projecting future losses and revenue.

Citigroup executives aren’t the only ones questioning the Fed’s methodology, either.

Elizabeth Warren, who chairs the Congressional Oversight Panel for the Troubled Asset Relief Program (TARP), is just as confused as the Citigroup execs.

“I had believed that we would receive a much more detailed description of the stress tests last Friday,” Warren, who is known as the TARP watchdog, said Monday at the Reuters Global Financial Regulation Summit.

Unlike Citigroup, however, Warren said that one of her main concerns is that the stress tests being applied by regulators are not stressful enough.

Calling the adverse scenario used to test the banks’ health “disturbingly close” to current economic conditions, Warren sparked concern that a second round of tests might be needed.

“The stress tests will make a terrific contribution if they are tough and transparent,” she said. “If they are not, they will be useless.”

The fear that the stress tests are causing more harm and doing more to detract from investor confidence than to inspire it has been an underlying theme of the government plan.

Analysts speculate if government officials – under fire for not being more forthcoming about the details of their evaluations – were to release the methodology of the stress tests, analysts would compare that test criteria to public financial data and start to draw their own conclusions about which banks are likely to fail or will require additional infusions of capital.

“They’ve gotten themselves in a pickle on this thing,” Bert Ely, an independent banking analyst told The Los Angeles Times. “It’s clear they didn’t think through how this was going to play out.”

The results of the test were initially scheduled for release on Monday, but the government has since said the results will be released later in the week.

[Editor's Note: Money Morning Contributing Editor Shah Gilani, a retired hedge-fund manager and a recognized expert on the global credit crisis, says the bank stress tests are stressing out investors. To read his analysis, which appears elsewhere in today's issue of Money Morning, please click Bank Stress Test Report. The report is free of charge.]

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• A parade of bellwether U.S. companies reported disappointing earnings results yesterday (Tuesday) and cut their outlook for the future. Caterpillar Inc. (CAT) reported its first loss since 1992 and cut its projection for the full year by 50%. Pharmaceutical giant Merck & Co, Inc. (MRK) and chemical maker E.I. du Pont de Nemours & Company (DD) said profits fell 57% and 59% respectively, as both cut forecasts for the full year.
• After acquiring Citigroup Inc.’s (C) Smith Barney retail brokerage unit, Morgan Stanley (MS) is considering buying U.S. regional banks in a move to boost the company’s retail brokerage operations, MarketWatch reported, citing an article in the Nikkei newspaper. “We are looking for potential opportunities to buy a bank that has a presence in an important market in the United States,” Morgan Stanley’s Chief Executive Offer John Mack said in an exclusive interview.
• Continuing to reel from the shift of advertising to the internet, the New York Times Co. (NYT) reported a first-quarter loss of $74.5 million, or 52 cents a share, MarketWatch reported. Excluding special items, the company reported a loss of 34 cents a share as first-quarter revenue tumbled 19% to $609 million. The Times, like many newspapers and magazines, is having a difficult time coping with an advertising downturn.
• Computer spies were able to copy and siphon data related to the design and electronics systems of the $300 billion Joint Strike Fighter project, The Wall Street Journal reported yesterday (Tuesday).  The newspaper quoted current and former government officials as saying the intruders have repeatedly breached the Pentagon’s computer networks, making it potentially easier to defend against the plane.  The spies could not access the most sensitive material, which is kept on computers that are not connected to the Internet. Lockheed Martin Corp. (LMT) is the lead contractor on the Defense Department’s costliest weapons program.
• Senior officials at the Federal Deposit Insurance Corp. (FDIC) have privately discussed who might replace Citigroup Inc. (C) Chief Executive Officer Vikram S. Pandit if the embattled banking giant needs additional federal capital infusions, The Financial Times and MarketWatch both reported. The FDIC identified Chief Financial Officer Edward J. “Ned” Kelly III and ex-CFO Gary Crittenden as possible successors. However, the published reports also state that any initiatives to change Citigroup’s top management will be initiated by the U.S. Treasury Department.
• The U.S. Treasury Department’s plan to excise $1 billion of so-called “toxic” assets from the balance sheets of U.S. banks is vulnerable to all types of abuse and fraud and needs the protection of tough conflict-of-interest rules, government bailout watchdog Neil Barofsky said in a report released yesterday (Tuesday). Barofsky, the special inspector general for the $700 billion Troubled Asset Relief Program (TARP), said subsidies for public-private investment partnerships (PPIP) to buy assets could expose taxpayers to higher losses – without offering accompanying increases in the profit opportunities this program is supposed to create, Reuters reported. During the rest of this week, the Treasury Department is accepting applications from asset managers to manage public-private investment funds to buy the hard-to-value, illiquid securities that are backed by troubled mortgages still owned by banks.
• In a report released yesterday (Tuesday), The International Monetary Fund (IMF) says banks and other financial institutions face aggregate losses of $4.1 trillion in the value of their holdings because of a global financial crisis that is “likely to be deep and long lasting.” In that Global Financial Stability Report – which has become a closely watched barometer of the severity of the crisis – the IMF estimated that financial institutions around the world will have to write down about $2.7 trillion worth of loans and securities that originated in the U.S. financial markets between 2007 and 2010. That estimate is up from $2.2 trillion in the fund’s report in January, and is way up from its October estimate of $1.4 trillion, according to The New York Times. Conditions have especially worsened in the emerging markets – and particularly in Europe – where banks face more write-downs and may require fresh equity, even as companies attempt to refinance existing debt. The IMF said banks will endure two-thirds of the write-downs, but noted that pension funds and insurance companies also face steep losses.
• The Reserve Bank of India yesterday (Tuesday) lowered its key borrowing rate by 25 basis points to 3.25% and its lending rate by 25 basis points to 4.75%.”The further policy rate cuts affected as part of this policy should be a definite signal for banks to reduce lending rates,” RBI Governor Duvvuri Subbarao said at a press briefing.

Source: Global Investment News Briefs Wednesday April 22, 2009

The financials appear to be reversing.

Just over 10 days ago, in a TD episode titled “Wait for a Reversal as Fed Folly Spreads,” we advised waiting for the rally in the financials to peter out… thus setting up a chance to short them again.

Here’s a chart of the financial SPDR (XLF:NYSE) as of Thursday’s close.

Two things are noticeable here. First, XLF has failed to hold the breakout attempt above its previous ceiling. Second, XLF has failed — yet again — to sustain a move above the 20- and 50-day moving averages (the red and blue lines). The Philly Bank Index shows a quite similar pattern to XLF.

As Hillary Clinton now knows, failure to follow through on a rally attempt is bad mojo indeed. A quick plunge lower isn’t guaranteed, of course. But nonetheless, this is a nice short setup. There will be some bearish trigger-pulling here soon.

Why is the rally failing? Perhaps because — surprise, surprise — the worst of the crisis is still to come.

On news of insurance giant AIG’s record $7.8 billion loss, The Wall Street Journal noted, “While the credit crunch may be easing on Wall Street, it appears to be tightening elsewhere. In the past week, U.S. regional banks have reported big losses and announced plans to raise fresh capital.”

So apparently there are more shoes to drop (big ugly ones, too). Gee, no one was expecting that, huh? Oh wait, that’s right… we were.

Part II of the China discussion, coming your way next week.

Last Friday, we discussed “The Riddle that is China.” As it turns out, more than a few Taipan Daily readers have spent time in China, and your experiences run the gamut.

Some of those responses will be served up next week — the good, the bad and the ugly — and we’ll also take a closer look at “how China did it.”

Jesse Livermore quotes are coming your way, too.

In Monday’s piece, “Playing the Odds Game,” I made note of the best trading book ever written, Reminiscences of a Stock Operator. The book, first published in 1923 and still in print, tells the story of the great trader Jesse Livermore. The response to my offer of Livermore quotes was overwhelming, so we’re working on that. Look for those quotes to be available soon.

Behold the “New Dow Transportation Index.”

Are the major market averages in a bear market? By some measures, yes; by others, no. We’ve certainly seen plenty of sectors and industries go their separate ways. In this 21st-century environment, it no longer makes sense to think in terms of all stocks going up or all stocks going down.

Bryan Bottarelli, of Bottarelli Research, believes that the major averages are NOT in a bear market. (The use of capital letters is his.)

Is he right? Hard to say. His conclusions are based on Dow Theory — a market discipline that makes sense to some and leaves others cold. (As for me, I prefer to avoid rigid classifications as a matter of habit… As Albert Einstein noted, “Things should be made as simple as possible, but not simpler.”)

Regardless of your opinion on Dow Theory, though, chances are you’ll find Bryan’s take on the “New Dow Transportation Index” interesting… and you’ll want to hear about the two small-cap stocks he’s recommending, both sporting 10%-plus dividends.