Next Up: Paying Back TARP Funds

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Includes: BAC, C, MS, WFC
by: Jim Delaney

When the Tim Geithner first brought up the concept of stress testing the banks, it was thought that things would not go well as the market place suspected many of the institutions would be found to be insolvent. The results have been released and in typical rumor vs. news fashion, the market seems to have liked what it was told.

In a somewhat rarer occurrence, the three main points of TG’s May 7th announcement [#1: Greater disclosure will help improve confidence; #2: Banks will be given a range of options to ensure they have a substantial capital cushion and #3: Some banks will be able to begin to repay the government] all seem to have gone, or are going, according to plan. Could we really be seeing a government intervention without “unintended consequences”?

With the announcement out of the way the job of raising the required capital was next on some bank’s “To Do” list. I thought it would be interesting to see how the CDS/equity relationship of some of these institutions has moved since the announcement.

BAC had the largest requirement ($33.9BN) of which it has raised $20.7BN through the sale of common shares and it’s stake in the China Construction Bank. On May 7th the benchmark CDS for BAC was 207bps and the stock closed at $13.51. The CDS has continued to move lower for BAC closing at 155bps on Friday. The shares have also moved lower though closing at $11.49 last week. While this is not the typical relationship we would expect to see between the CDS and equity it is understandable given the large share issuance. What the CDS movement is saying here is that the bank will be stronger when all is said and done, even if the equity holders take it on the chin in the meantime.

MS was told to raise $1.8BN to fluff up its capital cushion and used the opportunity to raise an additional $7.4BN by selling a total of $9.2 of common stock. The share holders faired a bit better with MS as did the CDS/equity relationship. The CDS level was 286bps and stock $27.14 for MS on 5/7. The stock closed last Friday at $28.23 and the CDS was quoted at 238bps.

WFC has seen the most dramatic drop in its CDS level since May 7th having closed that day at 167bps with the stock at $24.76. Friday’s levels were 120bps and 24.31 respectively. Worth noting is that the CDS level for WFC started moving lower in advance of the announcement having been quoted at 230bps on 5/5 and subsequently dropping 94bps to 135bps by May 8th. WFC’s stock hit a near term high on that day as well closing at $28.18.

Any discussion about the banks, stress tests and TARP money would be incomplete without mentioning the largest recipient of government largess, Citigroup (NYSE:C). After $45BN of your money and mine going to prop up Citi they were told to raise $5.5BN by the stress testers. This has been accomplished via an expanded conversion of preferred shares into common shares also giving Uncle Sam a nice big ownership stake in the bank.

The CDS level on C was 394bps on May 7th while the stock was trading at $3.81. Last Friday saw 348bps and $3.69 respectively. Given that many in the market place did not expect Citi to make it a quick look back shows the low on the stock of $1.02 on March 5th. The CDS was quoted at 580bps that day but moved higher 631bps on 3/9 and 666 on 4/1 even as the stock recovered from its nadir on 3/5 with closes of $1.05 on 3/9 and $2.68 on 4/1.

Next is the race to pay back the TARP funds. It’s safe to say that C won’t be the first to do so but it will be interesting to see how the CDS equity relationship moves for those that do.

Enjoy the “holiday shortened” week.