BofA, Citi Show Bank Cash Needs Run Deep

Bank of America and Citigroup this week showed that no matter how much aid the federal government bestows on banks, it may not be enough.
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Bank of America

(BAC) - Get Report

and

Citigroup

(C) - Get Report

this week showed that no matter how much aid the federal government bestows on the U.S. banking system, it may not be enough.

Just three months after the Treasury Department bought preferred equity stakes in nine large banks through the $700 billion Troubled Asset Relief Program, BofA and Citi -- each of which received $25 billion from the government -- were forced to take drastic action to recapitalize in the face of big fourth-quarter losses.

BofA needed Treasury to step in with a second investment and guarantee of risky assets picked up in its recent acquisition of

Merrill Lynch

. Citi, which similarly agreed to second round of federal aid in November, sold a majority stake in its Smith Barney brokerage to

Morgan Stanley

(MS) - Get Report

and announced a major restructuring plan.

With analysts saying 2009 could be even worse than last year in terms of deteriorating credit and economic conditions that haven't been seen since the Great Depression, Citi and BofA are unlikely to be the last banks to be in search of cash.

"The economic situation is likely to continue to worsen or the next few quarters and my sense is that these large banks are going to be forced to go back to the government, hat in hand, in order to beg for funds in order to survive," says Mark Fitzgibbon, the director of research at Sandler O'Neill & Partners. "The government is in the precarious position of helping these companies for fear of collapsing the whole financial

system."

Fitzgibbon says that given the troubles banks are having in the worsening economy, "capital standards will change" and become "much more onerous."

"The government is going to have to be more vigilant in overseeing this industry and I think the capital requirements are going to have to increase," he says.

BofA

said in conjunction with fourth-quarter earnings Friday morning that the government allotted an extra $20 billion of TARP money to the Charlotte, N.C., lender, on top of the $25 billion it received initially. The government also agreed to backstop $118 billion of toxic assets, primarily legacy positions from Merrill Lynch. BofA acquired the brokerage firm on Jan. 1.

Additionally, BofA posted a net loss of $1.79 billion, or 48 cents a share, for the fourth quarter and slashed its dividend to one cent a share. A year earlier BofA had posted profit of $268 million, or 5 cents a share, for the quarter.

The fresh capital is similar to Citi's second injection from the TARP fund in late November. The company has raised some $45 billion through TARP while the government agreed to backstop some $300 billion in risky assets.

Some analysts say BofA will still have to go back for additional capital.

Richard Staite, an analyst in London at Atlantic Equities says BofA's government package "does not solve" the company's "shortage of common equity."

Staite estimates the banking institution needs an additional $25 billion of common equity, according to a note Friday.

"

Thus there is the risk of a dilutive capital raise," he writes. "The capital shortage has been exacerbated by the Merrill loss and may increase further if the economic environment continues to deteriorate."

UBS analyst Matthew O'Connor presented a similar argument, saying BofA's government agreement will "reduce future losses and further boost liquidity." He said, however, that "it's unclear how

the bank will rebuild common equity without significant common equity issuance over time," according to a note.

Late Friday Moody's Investor Services downgraded BofA and Merrill Lynch and their subsidiaries to single A1 from double A3 on capital concerns. Moody's is concerned that Merrill's losses stem beyond the pool of assets the federal government is backstopping. Additionally, BofA's tangible common equity position has been weakened from the losses in the fourth quarter.

"

We believe the bank is unlikely to generate much capital over the next year and a half due to the need to sustain high loan-loss provisions to absorb higher credit costs, most notably in credit cards and residential real estate loans," a Moody's analyst wrote.

Moody's also placed Citi's debt ratings on review for possible downgrade to assess "potential for and possible implications of further systemic support, Citigroup's financial prospects and the credit implications of Citigroup's strategic initiatives," it said.

Outgoing Treasury Secretary

Henry Paulson

told reporters on Friday that a large portion of the second half of the $700 billion Troubled Asset Relief Program, or TARP, should be used to inject capital into struggling banks.

Lawmakers approved a request from the incoming Obama administration to access the second $350 billion on Thursday.

Critics of the capital purchase program say the money to be used to facilitate lending at the banks and on additional foreclosure programs, rather than to invest further in bank stocks.

Reuters

reported that with BofA's additional capital injection, the government has overallocated the first half of the TARP fund by nearly $25 billion.

Oppenheimer analyst Meredith Whitney has been adamant that most banks will run through their TARP money quickly and be forced to raise additional capital.

"As fundamentals continue to devolve, more voids will be created in banks' core capital positions (even inclusive of new TARP infusions) and we believe once again banks will have to raise fresh capital in 2009," Whitney wrote in a Jan. 6 note.

Whitney predicts that the large-cap banks under her coverage list will write down and take credit charges totaling $40 billion in the fourth quarter.

She reiterated her concerns in the note regarding the "direct correlation" between rating agency downgrades on troubled securities and banks' capital requirements.

"Such a relationship combined with the massive devaluation of housing related assets has resulted in large capital voids at banks and subsequently hundreds of billions of dollars in new capital being raised for the industry," Whitney wrote.

Still, Fox-Pitt Kelton Caronia Cochran Waller analyst Andrew Marquardt worries about "franchise erosion," at banks with large government ownership stakes like BofA and Citi, meaning that "clients just don't want to do business with you," on concerns of further capital raises and knowing that the company did not do a good job of managing the ship.

"I thought

Bank of America was going to get by without additional capital, but the credit marks were far worse and earnings ability was far lower," Marquardt says.