KBW Said Banking Industry Needs $1 Trillion In Capital, Said BofA (BAC) Most Likely To Convert

Analysts at Keefe, Bruyette and Woods commented on the upcoming stress test results and conducted their own stress test analysis on the U.S. banking industry, which concluded that $1 trillion of capital would be needed industry-wide. They said this additional capital would bring about strong ending loan loss reserve level of 200 basis points, a tangible common equity ratio well in excess of 5%, and the achievement of all regulatory capital levels required to be classified as "well capitalized."

KBW highlighted some of the details that have been reported in the media, which they said remains murky. Government documents reportedly showed that the stress tests would include loss rates based on an unemployment rate rising to 10.3% in 2010 including: first lien mortgage at 8.5%, home equity loans at 11.0%, commercial at 8.0%, commercial real estate at 12.0% and credit cards at 20%.

KBW performed their own stress test individual on 17 of the 19 companies that will be included in the government stress test, saying there is simply no "one size fits all stress test."

The firm said Bank of America (NYSE: BAC) is most likely to convert some TARP to CAP. KBW said, "While we believe that BAC will pass the government-based stress test, with this thin level of TCE projected, we feel BAC may be a good candidate for the government to force to take CAP. We believe this will happen and BAC will take between $15 billion and $20 billion of CAP." They said this could lead to 30% government ownership, and dilution of normalized EPS from $4 per share to $2.90 per share.

The firm said BB&T (NYSE: BBT) will most likely announce its intentions to repay TARP and to cut the dividend.

The firm said Bank of New York Mellon (NYSE: BK) will likely pass the stress test given healthy internal capital generation, recently announced dividend cut and considerable mark down of its AFS portfolio to date.

The firm said Capital One (NYSE: COF) can avoid capital raise even in an adverse scenario.

The firm said Fitth Third (Nasdaq: FITB) may need $1.1 billion in additional capital in order to achieve a cycle-end TCE/TA ratio of 6.0%, an appropriate capital level for the company.

The firm said Goldman Sachs (NYSE: GS) will pass the stress test and will be the first to attempt to repay TARP after results are released.

The firm said they don't believe JP Morgan (NYSE: JPM) will have to convert TARP to CAP. The firm said, "In our stress case analysis, we believe JPM may require an additional $10 billion of capital to maintain a TCE-to-managed asset ratio in excess of 4.20%. We note that this analysis incorporates our downside scenario for the possible changes in FAS 140/FIN46, which is the main driver behind the capital raise. Excluding a capital raise, we forecast JPM's TCE ratio to be approximately 3.80% under this scenario." They said even if JPM has to raise capital they won't need to go to the government as they could raise the capital efficiently in the private markets and repay TARP.

The firm said KeyCorp (NYSE: KEY) may need to raise capital, but has flexibility with existing convertible preferred securities. They see a possible capital raise of $1.25 billion, but note that KEY may have some capital flexibility with $659 million in convertible preferred securities, or more than 50% of our capital raise assumption. They already belive the markt has already significant dilution into KEY's share price.

On MetLife (NYSE: MET) the firm said it is how the Treasury stress test will be applied to MetLife since it is primarily a life insurer. They are not attempting to make a guess on the exact test outcomes on MET, but said they estimate two-year credit losses of $5.7 billion.

The firm believes Morgan Stanley (NYSE: MS) will likely demonstrate it does not need additional capital. They note that MS has not launched an equity offering, but said it is always possible.

The firm believes PNC Bank (NYSE: PNC) may need to raise capital to boost the TCE ratio above 3%. The firm said, "The recent reduction in the quarterly dividend was a necessary first step toward improving this ratio; however, we estimate the company may need to raise an additional $5 billion of capital in order to achieve a more appropriate cycle-end TCE ratio of 4.5% under our stress case analysis."

The firm said on Regions Financial Corp. (NYSE: RF) their base case ultimately calls for a $1.25B TARP/CAP conversion. "Our opinion is that the most likely outcome is that cumulative losses run in the 8% range and that RF will end up converting $1.25 billion of its $3.5 billion in TARP into the convertible CAP program. This has no impact on the regulatory ratios but would keep the converted TCE ratio above 5% for the cycle. In this scenario, RF would have a cycle-end tangible book value of $7.19 and normalized EPS of $1.46 and pro forma government ownership of common of 30% suggesting a stock price in the $5-$7 range even with a significant government ownership discount factored in."

The firm said on SunTrust Banks, Inc. (NYSE: STI) their base case calls for eventual $2 billion in TARP/CAP conversion or similar common stock raise. The firm said, "With STI's current capital structure and earnings power, we find that the cumulative loss rate range at which STI would want to raise additional capital would be 7% to 8%. Specifically, at 8% cumulative losses, we are estimating a 4.14% cycle-end common tangible equity ratio. With these expected losses over the next couple of years, we view SunTrust as being on the cusp of needing additional capital. Assuming our 8.03% cumulative loss estimate, we believe that STI will most likely need about $2.0 billion in common equity by the end of the cycle. While STI could well have the ability to raise common equity privately, we are currently estimating that STI will most likely convert about $2.0 billion of its existing $4.9 billion in TARP funds to the CAP program at the $13.71 conversion price. This would result in about 30% government ownership and normalized EPS in the $2.85 range, and tangible book per share would fall to about $20.24 at cycle- end. If STI were to convert its entire $4.9 billion in TARP funds into the CAP preferred program, it would still result in a tangible book per share of $17 at cycle-end and normalized earnings in the $2.40 range both numbers of which would seemingly support a higher stock price, despite the pro forma 50% government ownership."

The firm said State Street Corp. (NYSE: STT) at the end of Q1 remained well above well-capitalized levels based on all the regulatory capital ratios, even assuming consolidation of its ABCP conduit. The firm expects STT to pass the test.

On US Bancorp (NYSE: USB), the firm said, "Despite a relatively low TCE/TA ratio of approximately 3.70% at 1Q09, we do not believe USB will require additional capital following its recent dividend cut owing to its industry-leading pre-tax, pre-provision ROA in excess of 3.00%."

On Wells Fargo (NYSE: WFC), the firm said the company reported an improved level of tangible common equity at the end of the first quarter at 3.28%, which benefited from accounting changes as well as positive quarterly earnings. They expect capital to remain under pressure at WFC. The firm maintains that, "through the next two years WFC will need to raise as much as $50 billion in common equity, including $25 billion to repay TARP. We note that WFC does have strong pre-provision earnings, which we estimate at 300 basis points, helping to ensure rapid regulatory capital growth when it emerges from economic downturn."

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