Bank of America needs to add $34 billion to its cushion against future losses, but the Charlotte bank may not have to raise new money from the government or private investors, according to people familiar with bank stress tests to be released today.
Instead, the Charlotte-based bank could muster the capital that regulators require by converting government or privately held preferred shares into the type of capital — common equity — that is considered a better buffer against losses, analysts said Wednesday. The bank could also raise money by selling businesses or shares it holds in foreign banks.
That news cheered investors Wednesday, even though Bank of America appears to need more capital than previously expected. The bank's shares climbed 17 percent to $12.69, their highest closing price since Jan. 9.
Still, the need for more capital indicates regulators have concerns about the possible loan losses the bank could incur over the next two years should economic conditions deteriorate further.
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The government is likely to remain a significant shareholder in the company, either in the form of preferred shares that pay dividends or common shares that come with voting rights. Bank of America chief executive Ken Lewis has repeatedly vowed to shed the government yoke as soon as possible.
"The fact that we have some certainty (about how much capital Bank of America needs) counts for something," said James Early, an analyst at The Motley Fool. But overall, the results of the stress test are just “an indication of what the government is going to do. It's not a measure of how healthy Bank of America is."
The stress test results are the latest milestone in a turbulent year for the bank, which since January has received more government aid, faced investigations of its Merrill Lynch acquisition, rebounded from a fourth-quarter loss and seen Lewis stripped of his chairmanship after last week's annual shareholder meeting.
What the bank's capital gap means to Lewis' job security is unclear, although the board has signaled its support for him. New board Chairman Walter Massey couldn't be reached for comment Wednesday.
The government in February announced plans to stress-test the nation's 19 biggest bank holding companies, hoping to reassure the public about the industry's solvency. The tests' purpose is to make sure banks have enough capital to absorb loan losses in “what-if scenarios” that include a further rise in U.S. unemployment. The results were supposed to be kept quiet until 5 p.m. today, but leaks began emerging Tuesday.
Bank of America, the nation's biggest bank, appears to need the most capital. CreditSights analyst David Hendler said that could be due to its heavier concentration of construction and commercial real estate loans, which are showing rising delinquencies.
The bank already is one of the biggest recipients of government loans, accepting $45billion partly to stabilize its Jan. 1 Merrill Lynch acquisition. The government has also agreed to protect it from losses on $118 billion in assets, mostly from the Merrill portfolio.
Bank of America spokesman Bob Stickler declined to comment on Wednesday, saying the Federal Reserve has instructed banks "not to talk about this." The bank will hold a conference call for investors today.
A New York Times report on Bank of America's capital needs quoted the bank's chief administrative officer Steele Alphin, despite the government's secrecy demands. Alphin, whose responsibilities include corporate communications, is a longtime confidant of Lewis. Stickler declined to comment on Alphin's remarks. A Fed spokesman also declined to comment.
The bank should have several options for how to increase its capital levels. It could convert preferred shares, try to raise money from private investors or sell assets. With any of those moves, the government would still have a significant stake in the bank, but wouldn't require extra taxpayer funds.
If Bank of America decided to convert any of its $45 billion in government-owned preferred shares, it would dilute the value of shares held by common stockholders. It would also give the government more control over the bank because common shares carry shareholder voting power. And it would put taxpayers at greater risk, because common shareholders are often the last group to collect in a bankruptcy, and get lower dividend payouts than preferred shareholders.
Citigroup in February announced plans to convert some of its government- and private-owned preferred shares to common stock. In an interview with the Observer in March, Lewis said he didn't think his bank would need to do the same thing.
Bank of America could also convert preferred shares held by private investors, preventing the government from obtaining a voting stake. Bank of America has $33.9 billion in preferred shares held by private investors, which Stifel Nicolaus analyst Christopher Mutascio noted was "ironically" the same amount of additional capital buffer it needs.
Analysts think Bank of America also has a number of options for selling assets to help fill capital needs. The bank is in the process of selling off First Republic, a high-end bank it inherited from Merrill. There's speculation it will sell Columbia Management, an asset manager, and it could also sell Balboa Insurance, which it inherited when it bought Countrywide Financial last year, said Andrew Marquardt of Fox-Pitt Kelton Cochran Caronia Waller. And it could reduce its stake in banks in Brazil and Mexico, which together represent about $4.7 billion, Marquardt said.
Not all analysts think the stress tests are a good idea, saying they're redundant to the banks' own tests or could decrease lending because of the emphasis on raising capital levels.
Wednesday, the criticism intensified, with some analysts casting doubt on the tests' credibility. Olivier Garret, CEO of Casey Research, said the stress tests were "mostly an exercise in reassuring the public" and "were tailored to make sure the news wasn't too good or too bad."
"If it was too good it wouldn't be credible, and if it really showed the true health of the financial system, you would have a run on the banks," Garret said. "The fact is, those banks have a lot of toxic assets on their balance sheets, and that hasn't been addressed. . . . We are far from being out of the hole."
There's also little consensus on how hard or easy the tests were. "The government is speaking out of both sides of its mouth," said Rochdale Securities analyst Dick Bove, who thinks the tests are unrealistically harsh. "It's going to Congress saying the economy will be up next year, and out of the other side it's stressing bank portfolios and saying the economy will be down."
Late Wednesday, the banking industry's regulatory agencies said banks that "fail" the stress test will have until June 8 to submit a plan for raising capital levels. They'll have until Nov. 9 to implement those plans.
The banks will be encouraged to raise capital from private sources instead of the government, by selling business lines, selling assets to the government's "bad bank," or cutting shareholder dividends.
As they prepare their plans, the banks will need to review their "existing management and board in order to assure that the leadership of the firm has sufficient expertise and ability to manage the risks presented by the current economic environment and maintain balance sheet capacity" needed to meet the country's lending needs, the regulators said.
In March, the White House asked General Motors CEO Rick Wagoner to step down, and on Wednesday White House spokesman Robert Gibbs did not rule out similar moves in the financial sector, saying the current and past administrations have "weighed in" on CEO changes when significant taxpayer stakes are involved.
"We'll have to wait and see what these individual tests bring," Gibbs said during his daily briefing.