MarketView for May 7

 

 

Summary 

 

There was profit taking on Wall Street on Thursday as analyst downgrades hurt telecoms and a tepid response to a government bond auction raised fears about public finances. Bank stocks also succumbed to profit-taking, a day after leaked results from so-called stress tests suggested that most banks were healthier than previously thought.

 

Nonetheless, stock index futures rose after the official government results were released as regulators told leading banks to raise $74.6 billion to build a capital cushion officials hope will restore faith in financial firms and set a course out of the deepest recession in decades.

 

Shares of several major banks, including Citigroup were also higher after the bell, with Citi gaining 6.6 percent to $4.06 after regulators indicated that the bank's capital need was $5.5 billion. Citi had ended the regular session down 1.3 percent.

 

Looking at some other banks stocks, shares of JPMorgan Chase fell 5.3 percent to $35.24 in regular trading, and were little changed after the stress test results. The government concluded that the bank had no need to raise additional capital.

 

Shares of Bank of America were up 6.8 percent after the bell to $14.43 after regulators stated that the bank would need $33.9 billion of fresh capital, in line with what had been leaked earlier. The stock had ended regular trading up 6.5 percent.

 

Wells Fargo slid 7.8 percent to $24.76 in regular trading. After the bell the bank announced a $6 billion common stock offering. At the same time, regulators told the bank to raise $13.7 billion of capital by November 9.

 

During the regular trading session there was concern that poor demand for government debt could raise the cost of capital and hamper chances of an economic recovery. The $14 billion Treasury bond auction met below-average demand from investors, who bid aggressively to force the government to pay a higher yield as it pushed ahead with plans to help finance its burgeoning budget deficit with additional longer term debt. Treasury debt prices slid, sending the 30-year Treasury bond yield to its highest since November.

 

Shares of IBM were down 2 percent to $102.59, making it the largest drag among the components of the Dow Jones industrial average, while Apple, down 2.6 percent, pressured the Nasdaq.

 

The semiconductor index .SOXX fell 6 percent, but is still up 33.6 percent since the broader market's 12-year low of March 9. Tech has provided a crucial underpinning of the market's run-up since then, along with bank stocks. Other tech casualties included Hewlett-Packard, off 5 percent at $34.53 and Qualcomm, down 3.2 percent to $42.34. Shares of Cisco also were down, falling 3.4 percent to $18.95 despite some stronger-than-expected quarterly earnings late Wednesday.

 

Shares of key manufacturers were hit hard, with Caterpillar sliding 5.2 percent to $37.92.

 

Crude At 6-month High

 

Oil prices closed at a six-month high on Thursday amid simmering hopes for an economic recovery that could lift ailing world energy demand. Sweet domestic crude futures for May delivery settled up 37 cents per barrel at $56.71, making it the highest settlement since November 14, after hitting a peak of $58.57 earlier in the session. London Brent crude settled up 32 cents per barrel at $56.47.

 

Oil prices are up in price by more than 10 percent in two weeks, due in large part to mounting evidence that the global economic crisis is easing, paving the way for a rebound in world oil consumption. Encouraging this optimism was the Labor Department data on Thursday indicating that the number of workers filing new claims for jobless aid unexpectedly fell by 34,000 last week.

 

Oil's gains were also pegged in part to government data showing a smaller-than-expected increase in U.S. crude stockpiles. Crude stocks are running at their highest since 1990 as a slowdown in demand backs more barrels into storage.

 

Saudi Arabia, the world's top oil supplier, said it would not raise supplies for the time being as it attempts to shore up prices. The kingdom is pumping below 8 million barrels per day (bpd) and is unlikely to increase that production as world supply continues to outpace demand, Saudi Aramco Chief Executive Khalid al-Falih said on Wednesday. OPEC producers have agreed to cut some 4.2 million barrels per day from the world market since September.

 

Chairman of New York Fed Resigns

 

Stephen Friedman, chairman of the New York Federal Reserve Bank's board of directors, resigned on Thursday amid questions about his purchases of stock in his former firm, Goldman Sachs. Friedman, a retired chairman of Goldman Sachs who has led the New York Fed's board since January 2008, said he quit to prevent criticism about his stock buying from becoming a distraction as the Fed battles a severe U.S. recession.

 

"Although I have been in compliance with the rules, my public service motivated continuation on the Reserve Bank Board is being mischaracterized as improper," he said in a letter of resignation to New York Fed President William Dudley.

 

"The Federal Reserve System has important work to do and does not need this distraction," Friedman said.

 

Friedman bought Goldman shares in December 2008 and in January of this year, which became public with a Wall Street Journal report on Monday. Friedman obtained a waiver of the bank stock ownership rules, which the Journal said was granted just before he bought stock in January, that allowed him to hold them until the end of this year. Last week, he said he would resign by then.

 

While the Fed was deciding whether or not to grant Friedman a waiver, he bought 37,300 Goldman shares on December 17, for an average price of $80.78, according to regulatory filings. Then on January 22, he bought 15,300 more shares for average prices of $66.19 and $67.12, according to filings with the U.S. Securities and Exchange Commission. The January purchase brought his total holdings to 98,600 shares.

 

Goldman shares closed on Thursday at $133.73, meaning Friedman has profited handsomely, earning more than $3 million in total on the two purchases.

 

"Clearly he should not have done that (bought more Goldman shares), and probably even before he did that, he should have gotten off the board," said Alfred Broaddus, former president of the Federal Reserve Bank of Richmond.

 

John Dunbar, a senior fellow at the Center for Public Integrity, a nonprofit watchdog group in Washington, said the stock purchases were a "complete conflict of interest." "It is almost comical. If you tried to do that in a more traditional Washington bureaucracy, there is no way on earth you would get away with that," he said.

 

Fed insiders were also troubled over the situation, which they felt cast a question mark over ethical standards at the central bank. "All the other banks are furious. No one else would have let this happen," said one official at another regional Fed bank. "We've always made people leave (to avoid a conflict)," said the official, who requested anonymity given the delicacy of the situation.

 

Of all the other regional Fed banks, only Minneapolis said that one of its directors had to apply for a waiver for bank shares he held last fall when a number of former non-bank financial firms sought banking holding company status.

 

Several regional Fed banks said that their internal practices would have prevented the problem cropping up in the first place. "It is our policy to ask them to divest or resign," said a spokeswoman for the Kansas City Fed said.

 

With Friedman's resignation, the New York Fed's board now has three vacancies. Indra Nooyi, chairman and CEO of PepsiCo, is no longer on the board and former Lehman Brothers chief executive Dick Fuld left in September.

 

Now Banks Need To Do Their Part

 

Regulators told the largest 19 banks on Thursday that some of them had to raise a total of $74.6 billion to build a capital cushion officials hope will restore faith in financial firms and set a course out of the deepest recession in decades.

 

Within minutes of release of the bank "stress test" results, which showed smaller capital needs than once feared, several of the 10 firms needing capital immediately issued statements detailing how they planned to raise it.

 

Bank of America which accounted for almost half of the total capital shortfall with $33.9 billion to be raised, said it planned to sell assets, issue $17 billion in common stock, and take other steps to fill the hole.

 

"We're going to be watching carefully to make sure they give us credible plans for raising capital and becoming privately owned again," Federal Reserve Chairman Ben Bernanke said at a news briefing, referring to the entire group and not just Bank of America.

 

The examinations, which involved more than 150 regulatory officials poring over the books of the 19 largest firms, effectively drew a line between healthy and weak, and quantified exactly how much those institutions struggling under the weight of souring loans must raise.

 

Several of the banks found to be adequately capitalized said they wanted to repay taxpayer money as soon as possible to get out from under the government yoke. Meanwhile, the relatively modest size of the hole discovered by regulators carrying out the tests, which were based on an "adverse" economic scenario, led to both applause from investors who believe the worst is over and skepticism among those who think the examination wasn't rigorous enough.

 

At least two banks viewed the government's assumptions as surprisingly gloomy. Wells Fargo said it did not get enough credit for its expected revenue over the coming quarters, calling the Federal Reserve's estimates "excessively conservative," and Citigroup Inc also said it expected to earn more revenue than the government forecast. The reviews, led by the Federal Reserve, were designed to gauge how the 19 banks would fare if the recession worsened.

 

Bank of America was found to have the largest capital need. However, it said it did not need any more government money. Some or all of its $17 billion of new common stock may be issued in exchange for privately held preferred shares, of which it has about $30 billion.

 

Wells Fargo was found to need $13.7 billion, auto and home loan finance company GMAC $11.5 billion, and Citigroup Inc $5.5 billion.

 

Several of the banks found to be in need of bigger buffers rushed to explain how they intend to raise the capital. Citigroup said it was seeking to exchange $5.5 billion in additional preferred securities for common stock to fill its shortfall.

 

The banks that have been told to build their capital cushion have until June 8 to develop a detailed plan and November 9 to implement it. Regulators had to walk a fine line as they sought to convince skeptical investors the reviews were sufficiently rigorous without unduly straining banks that were already in a precarious financial position.

 

The total figure appeared to be small enough to ensure that the White House would not have to approach Congress for more rescue money on top of the $700 billion approved last year, a request that would likely be turned down because of voter outrage over the bailouts.

 

The tests found that total credit losses for the 19 banks may reach $600 billion in 2009 and 2010. All told, if the economy performs as badly as the worst case scenario used in the stress test, the 19 banks' losses would amount to $950 billion from mid-2007 through 2010.

 

Banks may cover any capital shortfalls through a mixture of asset sales, share sales, and perhaps the conversion of preferred shares into common stock. Regulators have put special emphasis on holding common capital rather than preferred because stock investors view common as the best form of capital.

 

For many banks, converting government owned preferred shares into common could turn the federal government into the company's biggest shareholder.