MarketView for April 28

 

 

Summary  

 

Stock prices fell on Tuesday as new concerns evolved over the possibility that some of the major banks may have to raise additional capital which in turn offset the latest economic data that indicated the worst of the recession may be over and the latest dividend increase from IBM.

 

Regulators have apparently told Citigroup Inc it may need to raise more capital. The Wall Street Journal reported that Bank of America also is talking to the government about its capital condition and the shortfall could amount to billions of dollars.

 

Citigroup is talking to the government about its capital levels after receiving early results of its stress test, but if it needs more capital, the bank does not expect to get it from the government, people familiar with the matter told Reuters.

 

Bank of America's stock tumbled 8.6 percent to $8.15 and ranked among the top weights on the blue-chip Dow, while Citigroup lost 5.9 percent to $2.89.

 

In addition, there were lingering concerns over the potential impact the recent threat of a flu pandemic will have on the economy. New Zealand and Israel were the latest countries to confirm cases of a new strain of flu linked to dozens of deaths in Mexico. Meanwhile, economic data released on Tuesday indicated that the decline in home prices slowed in February, while consumer confidence in April had its largest increase in more than three years.

 

IBM gave the Dow a large boost, after its board approved a 10 percent increase in its dividend and authorized a stock buyback, highlighting resilience in a tough economic climate.

 

Economic Data Points Toward Recovery

 

Consumer confidence posted its largest increase in more than three years during April, while the decline in home prices showed signs of slowing in February, adding to hopes that the recession may be waning.

 

The Conference Board said its sentiment index climbed to 39.2 this month from an upwardly revised 26.9 in March. The April reading, which was above economists' median expectation of a reading of 29.8, was the highest since November 2008.

 

That report came on the heels of a report indicating that home prices were down nearly 19 percent for the month of February. However, for the first time in 16 months, the decline did not set a new record, according to the Standard & Poor's/Case-Shiller Home Price Indices.

 

Together, the two reports support arguments that the economy is at least reaching bottom, even though difficulties in the financial sector and the rising unemployment numbers are an indication that economic growth may still be a ways off.

 

Nonetheless, the increase in the consumer confidence index was the highest since November 2005, when sentiment began to recover from the aftermath of Hurricane Katrina. The survey's expectations index came in at 49.5 this month from 30.2 in March.

 

"The sharp increase in the expectations index suggests that consumers believe the economy is nearing a bottom, however this index remains well below levels associated with strong economic growth," said Lynn Franco, director of the industry group's Consumer Research Center.

 

Some of the confidence recovery was probably attributable to the rebound in stock prices, which staged an astounding rally of about 30 percent between mid-March and April.

 

Home prices extended their massive decline in February, even though there were signs that the slump was slowing. Housing prices were down 18.6 percent in February, compared to a year earlier. That was an improvement from the 19 percent decline recorded for the 12 months as of last January.

 

On a monthly basis, a composite index of 20 metropolitan areas fell 2.2 percent, more than expected but less than the 2.8 percent fall in January, raising hopes among some that the housing market might be approaching a bottom.

 

However, potential home buyers have been staying sidelined, waiting for the precipitous drop in prices to mitigate and for the economy to stabilize.

 

"While the declines in residential real estate continued into February, we witnessed some deceleration in the rate of decline in some of the markets," David Blitzer, chairman of the Index Committee at Standard & Poor's, said in a statement.

 

If home prices are in fact nearing bottom, it has been slow to come and only after many earlier hopes of stabilization proved illusory.

 

The breakdown of the data remained grim. Of the 20 metro areas, all recorded price drops on a month-on-month and year-on-year basis. Ten areas showed record rates of annual decline.

 

Historically, compared with their peaks in mid-2006, the 10-city index is down 31.6 percent and the 20-city index is down 30.7 percent. As of February, average home prices across the United States were at levels similar to where they were in the third quarter of 2003.

 

Price Of Crude Down Again

 

The price of crude oil futures fell again on Tuesday over concerns that the swine flu outbreak could further depress fuel demand, already hard hit by the global financial crisis. May futures settled down 22 cents per barrel at $49.92. London Brent settled down 33 cents per barrel at $49.99.

 

The new flu strain has spread to more countries, including Israel and New Zealand, raising the specter of a pandemic and hurting financial markets. It has hit airline stocks on expectations travel will be curtailed, and analysts warned jet fuel demand may slump, citing the drop in consumption that corresponded to the SARS epidemic in 2003.

 

Oil demand has already tumbled due to the global economic crisis, which has sent prices off record highs over $147 a barrel in July. Some industry experts said that with demand already depressed, the effects of the swine flu could be muted compared with SARS.

 

Crude stocks are expected to increase by 2.1 million barrels in the week to April 24, according to the poll, taken ahead of data from the American Petroleum Institute to be released later Tuesday and U.S. government data on Wednesday.

 

Citi and BofA May Need Additional Capital

 

Citigroup is under pressure to raise capital after discussing its stress-test results with government regulators, while the Wall Street Journal reported Bank of America may need billions in new capital.

 

The report triggered a new round of guesswork and analysis on Wall Street as investors tried to figure out which other banks might face pressure to raise capital. Wells Fargo & Co's shares fell as much as 5 percent, while Bank of America and Citigroup shares fell as much as 10 percent and 7 percent, respectively.

 

Bank of America may need to raise as much as $70 billion to maintain an acceptable tangible common equity ratio, a measure of capital strength, if unemployment rises.

 

Although both Citi and Bank of America posted better-than-expected first quarter numbers, the key question is whether the improvement can last given rising credit losses and the surprisingly high trading profits and one-time gains that helped first-quarter results.

 

Both banks received $45 billion in capital injections under the TARP program, more than any other major bank. At the same time, both banks are facing substantially greater consumer credit losses as unemployment reaches its highest level in a generation. Bank of America averaged more than $600 billion in consumer loans during the first quarter, while Citigroup averaged more than $500 billion.

 

These loans will generate interest income, but the interest income could be overcome by credit losses. Citi's tangible common equity ratio was 1.66 percent at the end of the first quarter. Converting preferred shares into common, coupled with the $2.7 billion sale of a stake in Smith Barney brokerage unit into a joint venture with Morgan Stanley, will raise that number to something in the range of 4.97 percent.

 

Bank of America's tangible common equity ratio is about 1.8 percent. If unemployment rises as high as 12 percent, it would need $60 billion to $70 billion to maintain its tangible common ratio above 3 percent which is expected to be the required level.

 

The cost of insuring Citigroup debt with credit default swaps rose 70 basis points to 615 basis points, while Bank of America's swaps widened by 25 basis points to 325 basis points, according to data from Phoenix Partners Group.

 

Both Bank of America and Citigroup, whose officials are objecting to the preliminary findings of the tests, plan to respond with detailed rebuttals, sources told the Journal, adding that Bank of America's appeal was expected by Tuesday.

 

The government said that results of the stress tests on the 19 largest U.S. banks will be released next week. The 19 banks tested hold two-thirds of the assets and more than half of the loans in the banking system. Some banks with too thin a capital cushion will have six months to find private funds; others may need to accept an immediate infusion of taxpayer money.