In practice, the banks will be under pressure to line up the new capital immediately

TO BE NOTED: From the NY Times:

"Citi Is Said to Require New Capital

By ERIC DASH

Citigroup is locked in negotiations with federal regulators over whether it needs to raise as much as $10 billion in fresh capital as a result of the government’s stress test of its financial health, according to a person briefed on the situation.

But the bank may be able to plug that hole with recent and future measures to raise capital — like asset sales and a big stock conversion plan — that could leave it with more than enough funds to satisfy regulators.

The size of any shortfall hinges on how much regulators will let the bank offset its projected capital needs with actual gains in the first three quarters of this year. Regulators are planning to let all 19 banks taking the stress test count, through the third quarter, any gains toward the cushion of capital they are required to hold against a worsening recession, according to people with knowledge of the plan.

But the calculations may add another layer of murkiness to the highly anticipated results, and could further undermine confidence in the exams themselves, by setting off a rolling reassessment of the amount of capital the banks must hold, analysts said.

Federal Reserve and Treasury Department officials said Friday they would delay the release of the stress test results until Thursday afternoon, several days later than they had originally expected, in part because some of the banks continued to disagree with the government’s initial conclusions.

The government plans to release both aggregate results for the entire group of banks and specific results for individual institutions, as well as estimates of the banks’ potential losses. The goal of the tests is to determine how much additional capital each big bank will need if the economic downturn proves to be deeper than expected. Many analysts expect several major institutions to be ordered to raise billions of dollars in additional capital.

Citigroup, Bank of America, PNC Financial and Wells Fargo and other lenders have been disputing the early findings of stress tests, arguing that they are in better financial health than the government has concluded, according to people briefed on the exams. Talks are expected to continue into next week.

The banks fear that if the tests require them to raise capital immediately, it may needlessly dilute existing shareholders if the economy worsens less, or less quickly, than regulators expect.

Regulators based their assumptions of how much capital banks need to hold in the future on the banks’ 2008 results. Now, if banks’ actual performance through the third quarter is better than expected, they can count that toward the amount of capital the tests would otherwise require them to raise, the people briefed on the matter said. Banks would also get credit for any business or loan portfolios they sell. Both actions would minimize the actual amount of capital the banks need.

But it also means that regulators may need to update their assessments of required capital as banks report their earnings in the coming quarters, which may create more uncertainty for investors who hoped that the results of the stress tests being released Thursday would be more definitive.

It is unclear whether the government’s capital requirements would change for a bank that reports large losses in the second and third quarters. Most banks enjoyed a rebound in earnings in the first quarter, but many have warned that those gains may trail off as the recession wears on.

“Conceptually it makes sense but it may not give investors the visibility they crave,” said John McDonald, an analyst at Sanford C. Bernstein & Company. On the other hand, he said, if the results of the stress tests Thursday provide a maximum amount of capital that banks can reduce on future events, “the risk is the banks raise more than they need and potentially dilute their shareholders or take on more government capital than necessary.”

The methodology could have a positive impact for a bank like Citigroup, which most likely needs billions of dollars of additional capital. On Friday, it announced the sale of Nikko Cordial Securities to Sumitomo Mitsui Financial, a large Japanese bank, in a move that would boost Citigroup’s tangible common equity by $2.5 billion. Citigroup has also announced the split-off of Smith Barney and plans to convert a portion of the government’s $45 billion preferred stock investment into common stock.

None of those actions counted in the preliminary stress test results that regulators revealed in secret last week to the banks. But regulators then allowed the banks to adjust those figures based on their actual first-quarter performance.

That could help reduce Citigroup’s total capital shortfall, though it is possible the bank may still need additional money.

Other banks, including Bank of America and Wells Fargo, are also pushing back hard on the regulators assumptions, including the severity of losses on assets like mortgages, credit card and commercial real estate loans, as well as their potential to generate earnings.

Banks that are ordered to raise capital will be required to submit a plan within one month and will have six months to actually raise the money. In practice, the banks will be under pressure to line up the new capital immediately, and several are expected to announce specific plans on the same day that the results are released.

Edmund L. Andrews contributed reporting."