Questions About Bank Stress Tests
Bank of America, Citigroup Told to Boost Capital as Validity of
Bank Stress Tests Is Called Into Question
Bank of America Corp. (BAC) and Citigroup Inc. (C) were told by federal regulators
to raise more capital after government "stress tests" revealed that the banks were not adequately protected against
additional deterioration in the economy, published reports said yesterday.
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
Analysts anticipate that some regional banks also will be required to raise more
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,"
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.
Will top banks CEOs be forced to
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
"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
"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
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,
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.
Note: Money Morning Contributing
Editor Shah Gilani,
a retired hedge-fund manager and a recognized expert on the global credit crisis.]