Evening Update

Sentiment Fluctuates as Stress Test Reports Flood the Market

Stocks, which began the day on a positive note following a much better-than-expected ADP jobs report, fluctuated midday, and ended the day higher. Investor sentiment shifted during the trading session as stress test reports were leaked throughout the day. Even though official final results are not expected until tomorrow, markets have been flooded with leaked tidbits of information related to the government’s stress tests. Reports now say Bank of America will need $34 billion, Citigroup will need between $5-10 billion, and Wells Fargo will need $15 billion, while a slew of banks including JP Morgan, Morgan Stanley, Goldman Sachs, Metlife, Bank of New York Mellon, and American Express are reported to have passed the tests with solid capital positions. It is important to note, however, that even the banks needing to improve their balance sheets have several options at their disposal besides raising new capital. In other equity news, Walt Disney and Transocean topped the Street's profit forecast, and PepsiCo raised its dividend. The auto sector was in the news again as GM presented its proposed restructuring plans to the SEC and Ford reiterated that its restructuring program is sufficient and it has no need for government assistance. Treasuries were little changed today.

The Dow Jones Industrial Average rose 1.2%, the S&P 500 Index gained 1.7%, while the Nasdaq Composite advanced 0.3%. In moderately high volume, 1.5 billion shares were traded on the NYSE, and 2.7 billion shares were traded on the Nasdaq. Crude oil was $2.50 higher at $56.34 per barrel, wholesale gasoline advanced $0.05 to $1.63 per gallon, while gold rose $14.10 to $911.25 per ounce.

According to multiple media outlets including the Wall Street Journal and the New York Times, Dow component Bank of America (BAC $12 ¹) has been told by the government that it has a $34 billion gap in its capital position. BAC has verified this figure but notes that it will have many options in making up the capital shortfall. Given that the government has already provided $45 billion in TARP funds to the bank, Bank of America could meet the requirement simply by converting those funds from preferred to common equity, and would not need more injections from the government. In that scenario, American taxpayers would lose the dividend and seniority rights that they currently posses with the preferred shares, and the U.S. government would become one of the largest owners of the bank. Existing shareholders in BAC would be diluted if this happens. Bank of America stock finished 16% higher today, despite the fact that this reported figure is three times larger than figures that had been leaked earlier in the week, suggesting that the Street may have been expecting an even worse outcome from the government stress tests.

Also included in the report was news that Citigroup (C $4) will need to raise between $5-10 billion in new capital. Citigroup executives have said that the bank will have no problems covering any shortfall and are considering several options to improve the bank’s balance sheet. Citigroup’s stock was also strong following this announcement, finishing up 15%.

Bloomberg news reported that Wells Fargo (WFC $27) will also need $15 billion in capital to meet government stress test requirements, citing a person familiar with the matter. Wells Fargo declined comment. The country’s fourth-largest bank traded up nearly 15% today.

Meanwhile, multiple media outlets have announced that a slew of other banks, including JP Morgan (JPM $37), Morgan Stanley (MS $28), Goldman Sachs (GS $140), Metlife (MET $32), Bank of New York Mellon (BK $30), and American Express (AXP $27 ¹) have passed the stress tests with no needs to improve their current capital position, citing people familiar with the matter who requested anonymity as they were not authorized to discuss the results. These banks did not comment on the rumors. Shares of all of these banks were up on the news.

FDIC Chairman Sheila Bair testified at a Senate hearing yesterday, calling for a larger regulatory system for America’s banks and stressing that the “too big to fail” policy used by the government to fight the crisis must end. In Fed Chairman Ben Bernanke’s testimony before Congress yesterday, he reiterated that the government will not be a “hands off” investor in these financial institutions and will take steps to make certain that bank management is “effective”. Bernanke repeated his stance that the government has no desire to be a long-term owner of these banks, but that it will likely be a “few years” before these firms can end their reliance on government support.

The final results of the U.S. government stress test on all 19 U.S. banks that have been tested are expected tomorrow after the close. Potential increases in federal regulation and involvement in the affairs of private businesses— including the government taking a larger stake in some of the country’s largest banks—could end up having long-lasting affects on the U.S. economy.

Dow member Walt Disney (DIS $26) reported that fiscal 2Q EPS ex-items fell by 26% to $0.43, three cents ahead of the Reuters estimate, as revenues declined 7% to $8.1 billion. The company said it had a difficult 2Q due to the weak economy and other factors. Revenue at its media networks rose 2%, but its parks and resorts and studio entertainment sales fell 12% and 21%, respectively. DIS traded over 10% higher.

Offshore driller Transocean (RIG $75) reported 1Q EPS ex-items of $3.75, topping the consensus estimate of $3.50, as revenues declined 4.6% versus last quarter to $3.1 billion. The company said profits were negatively impacted by lower oil and gas prices but operating and maintenance expenses declined on reduced non-drilling activity, a reduction in shipyard and maintenance projects, strengthening of the US dollar, and decreases in drilling activity. Shares were higher.

PepsiCo (PEP $50) declared a 6% increase in its annual dividend, from $1.70 per share to $1.80 per share. The food conglomerate said the increase reflects the strength of its cash flow and balance sheet. Shares were flat despite the report.

General Motors (GM $2) shares were down over 10% after the struggling car maker presented a regulatory filing with the SEC which showed that the government could end up owning over 50% of the company and current common stockholders will be left with roughly a 1% stake if the proposed restructuring plan is accepted. This deal hinges on convincing GM’s bondholders and the UAW to accept GM stock in exchange for the debt obligations they currently hold. The Obama administration has given GM a June 1 deadline to conclude negotiations if it hopes to avoid the bankruptcy that fellow Big 3 automaker, privately-held Chrysler, was forced into after failing to reach an agreement with its creditors. The current market value of GM’s stock is just over $1 billion while management is asking its creditors to write off at least $43 billion in debt in exchange for ownership of a restructured company. The shares have lost over 90% of their value over the last year.

Meanwhile, Ford (F $6) announced that it is investing $550 million in a former truck plant near Detroit to convert the plant to producing small cars. Ford’s management reiterated that their company, the only one of the Big 3 that hasn’t taken government help, is in strong financial shape and is in ongoing discussions with the UAW to ensure competitiveness with GM and Chrysler. Ford shares were up 7%.

Private sector jobs fall less than expected

Treasuries were little changed after another positive surprise in economic data. The yields on the 2-year and 10-year notes were unchanged at 0.96% and 3.16% respectively, while the yield on the 30-year bond gained 2 bp to 4.09%.

ADP reported that private sector jobs fell 491,000 in April, much less than the Bloomberg estimate of a loss of 645,000 jobs, and much better than the March figure which was upwardly revised from -742,000 to -708,000. The ADP report is the first read on employment conditions this week, which will culminate with the labor report from the Bureau of Labor Statistics on Friday. Unlike the ADP report, the BLS will include government jobs in its report.

In other economic news, the US MBA Mortgage Application Index increased 2.0% to 979.7 for the week ended May 1. The Refinance Index rose 1.2% to 5169.3, and the Purchase Index advanced, rising 5.0% to 264.3. The Mortgage Bankers Association (MBA) said the average 30-year fixed loan rose 17 basis points to 4.79%. The report may be welcome news for the housing front as the Purchase Index led the overall increase in applications, suggesting some homebuyers are warming up to the near record low mortgage rates and increasing housing affordability.

Elsewhere, crude oil inventories rose by 600,000 barrels, versus the Reuters forecast of a 2.6 million barrel increase, gasoline stockpiles unexpectedly fell by 200,000 barrels, compared to the 700,000 barrel increase that was expected, and distillate inventories rose 2.4 million, above the 1 million barrel forecast. Crude oil and gasoline prices jumped after the report.

A host of economic reports are on tap for tomorrow, including nonfarm productivity, unit labor costs, initial jobless claims, and consumer credit. Initial jobless claims are expected to stay relatively flat at 635,000 versus 631,000 in the last report.