Analysts see U.S. government's move as a net positive for banks
BANGALORE (Reuters) - Wall Street analysts on Thursday hailed the U.S. government's capital assistance program as a positive for banks, but said near-term earnings will remain under pressure due to rising provisions for bad loans and overall weakness in the economy.
U.S. banking regulators on Wednesday launched a "stress test" program to assess larger banks' ability to cope with a deeper and longer-than-expected recession that could see the unemployment rate climb above 10 percent next year.
The stress tests, mandatory for institutions with more than $100 billion in assets, will be partly used to determine whether the banks need additional capital from a new U.S. Treasury program for government investment in convertible preferred shares.
"The CAP plan is also largely as we expected, and is good news, in that the government is not going to blindly jam common (equity) into banks without knowing which will ultimately need it," Fox-Pitt analyst David Trone said.
U.S. bank stocks rose on hopes that the "stress test" will help the ailing sector get closer to a fix, and on diminished fears about nationalization of the banks.
The program will allow firms that show inadequate capital buffer under the test and cannot raise private capital to issue mandatory convertible preferred shares to the U.S. Treasury, a move that should alleviate fears about tangible common equity (TCE) levels, UBS said.
Tangible common equity is a measure of how much common equity is supporting a company. It ignores intangible assets such as goodwill on the theory that in bad times, intangible assets are less likely to have value.
UBS said dilution "remains a major concern" for companies receiving government aid.
"Given its relatively low TCE ratio, we expect Citi to tap the Capital Assistance Program which could lead to meaningful dilution," it said in a note to clients.
Citigroup and Bank of America have each received $45 billion in government capital in recent months and guarantees against losses on portfolios of illiquid mortgage assets -- aid that now exceeds their market value.
Only Citigroup and to a lesser extent Bank of America appear to have the need to take actions beyond the CAP, Barclays analyst Jason Goldberg said.
Both banks have been the subject of much speculation about nationalization.
However, Citigroup analyst Keith Horowitz said Bank of America and Fifth Third do not need to issue more equity and if they do need to, the conversion price is well above current prices.
"Also, these stocks are pricing in significant dilution, and we believe risk/reward is excellent at these levels."
Citigroup began raising capital aggressively in late 2007, drawing off sources such as Abu Dhabi Investment Authority, Kuwait Investment Authority and Singapore Investment Corp. Saudi Prince Alwaleed bin Talal, the bank's largest individual shareholder, also boosted his stake.
"We still believe that Citigroup may get an immediate common injection given its uniquely weakened state," Fox-Pitt's Trone said.
Earlier this week, Citigroup, whose stock has been pounded by fears that the government may seize the bank and wipe out shareholders, was in talks to give the government a larger stake, a person familiar with the matter told Reuters.
Analysts also expect bank stocks to rally in the short term, spurred by government's action, but remained concerned about the banks' ability to sustain the upside.
"We expect this group to be dead-money for a while as investors assess which banks are better positioned to deal with the ongoing credit cycle," analyst Robert Patten of Morgan Keegan said in a note to clients.
The KBW Bank Index of larger lenders was up 7 percent in afternoon trade. Bank of America shares rose nearly 9 percent to $5.62, while those of JPMorgan Chase & Co jumped 8 percent to $23.54 and Citigroup was trading flat at $2.54.
(Editing by Amitha Rajan)