May 8, 2009: Morning Call

May 8, 2009: Morning Call

Fair Value: SP500 – 905.28; NDX: 1389.71; DOW: 8379.67

Technical Levels:

SPX: 676, 719, 765, 788 support/ 898, 943 resistance

Events:

Pre-market EPS: EP (.28/1.29B); HUN (-.21/342.7M); MIR (.57/494.2M)
08:30: Change in Nonfarm Payrolls (April): -610,000; Unemployment Rate: 8.9%
08:30: Change in Manufacturing Payrolls: -159,000
08:30: Avg. Hourly Earnings: 0.2% MoM; 3.3% YoY
09:30: GS Annual Meeting
10:00; Wholesale Inventories (March): -1.0%
13:00: Fed’s Lacker speaks on the economy
Post-market EPS: PCLN (.91/442.5M)

Foreign Market Summary/Key Macro News/Commentary:

The S&P future are trading 14 points above fair value while the NASDAQ futures are trading 17 points above fair value with the financial stocks surging higher on optimism that US banks have adequate capital to absorb future losses. Adding fuel to the rally is the perception that many long-only mutual fund managers are scrambling to add bank equity to increase their exposure to the sector. European markets are at the highs of the session with gains of 2.0%-2.5%. Banks and financials were amongst the leading sectors following the results of the US's stress tests on financial institutions. Advancers on the FTSE 100 lead decliners 7-3. Trading higher after results are Commerzbank (CBK.GR), Royal Bank of Scotland (RBS.LN), Repsol (REP.SM) and Luxottica Group (LUX.IM). Trading lower on results was Puma (PUM.GR) and Taylor Wimpey (TW.LN) fell after announcing a rights issue. Asian markets: mostly rose led by financials following their US peers up in after-hours trade, and energy shares on higher oil prices. Mining shares retreated as metal prices fell. In Hong Kong, aluminum-extraction products maker China Zhongwang Holdings (1333.HK) fell (5%) on its IPO and Geely Automobile Holdings (175.HK) retreated after saying it would not bid for Volvo or Saab. Financials gained when the Hong Kong Monetary Authority chairman said the banking system is healthy. Toyota (7203.JP) fell on a report it would post a larger-than-expected loss for the FY.

Research Calls/Market Moving News:

Stress tests predict $599B in cumulative losses at 19 tested banks through 2010 if economy goes south – WSJ: The Federal Reserve's figure was smaller than some had feared. The article summarizes the presentation of the results yesterday, with a lot of information that has already been reported about the various options different banks now have or the plans some banks announced after the results were revealed.

Bank of America discusses some of the ways it plans to raise capital - conf. Call: BofA is targeting a $17B increase in Tier 1 common equity. It is planning to generate this equity from a combination of an ATM offering (sale of common stock through normal trading), as well as a possible tender offer to convert non-government preferred stock held by institutional investors into common stock. Tomorrow morning, the bank will launch an offering to sell up to 1.25B shares of common stock through an ATM program. Later this month, it will look to launch an exchange offer targeted at some of its institutionally-held perpetual preferred and convertible preferred stock. The bank is only looking to exchange a portion of the total, and expects that the exchange pricing would reflect a discount to par value of the preferred securities. The bank has not decided on a form for the exchange, but it could include privately-negotiated transactions or a Dutch auction. BofA adds that it is also looking to raise about $10B through asset sales (says Columbia and First Republic may be sold, also looking at two joint ventures....notes that asset sales have multiple bidders). BofA also expects to generate $7B in PPNR over the next two quarters to help plug the shortfall. Also of interest, BofA says that it is in talks to end the asset wrap offered by the government in January. This would mean that the bank would not have to issue the government the $4B in additional preferred securities.

FBR's bank analyst Paul Miller comments on the stress test results: The most important result of the government's stress test is stronger tangible common equity ratios for the group, and given recent share price strength, it comes with less dilution than we feared. The lower dilution risk should limit the downside for financials, at least in the near term. Our negative thesis on U.S. banks has been based on (1) the risk of failure or significant dilution given the lack of tangible common equity in the financial system; and (2) the prospect of unprecedented losses given 30%+ national home price declines, rapidly growing unemployment, and weak underwriting in recent years. The first of our concerns is clearly mitigated by the government's requirement that 10 of the biggest U.S. banks boost their tangible common equity by $75 billion, in addition to the government's commitment not to let these institutions fail. Further, we have to acknowledge the recent market strength. We note that the stress-tested banks now trade at an average of 52% above their "cap price," which suggests substantially less dilution and less risk of government ownership than we previously feared. Despite these positives on the capital front, our concern over industry losses persists. If we are correct and unemployment exceeds the government's 10.3% stress test level, these companies may still need more capital. We believe that many market participants remain overly optimistic about the near-term earnings prospects of these companies given that real estate cycles typically take five to six years to work through. Over time, the macro picture will become more clear, but today we find some comfort in the prospects of stronger tangible common equity levels. Recent events – the banks are getting common equity! On May 7, the Federal Reserve published the results of its long-anticipated stress test, requiring 10 bank holding companies to fortify their common equity by $75 billion. While the banks don't all fully agree with the Federal Reserve's assessment, they will have to boost their capital anyway. We consider a stronger common equity base to be a positive for the space, particularly as the dilution could be less today than we previously feared.
• FBR takeaway. Capital markets can be fickle, which is why we would encourage companies to raise or convert preferreds as soon as possible. To wait is to gamble, and while that bet has paid off handsomely over the past two months, historically it has not. Further, there could be difficulties convincing preferred holders to convert to common. While dilution risk appears quantifiable and less than feared, the capital raise is not a done deal yet. We again encourage companies to take advantage of recent share price strength and the market's apparent appetite for capital offerings to solidify their tangible common equity quickly. • Value add: sufficient capital up to 10.3% unemployment. We feared that the government's stress test would be too lenient or would attempt to build confidence in banks without real substance; we now acknowledge that the loan loss expectations and earnings power assumptions in the test are credible if the unemployment rate peaks at 10.3%. While we are still concerned that unemployment and losses will exceed this level, the government's test goes a long way to improve these companies' capital structures now. Further, even if we expect more capital will be needed down the road, the market will generally value these companies as if this is the last capital raise (at least in the near term).

MRO (31.66); MUR (53.56): Goldman Sachs downgrades MRO, MUR: Murphy Oil (MUR) downgraded to neutral from buy, target increased to $64 from $55. Marathon Oil (MRO) downgraded to sell from neutral, however target increased to $35 from $31.

MS (27.14): Morgan Stanley announces $2B secondary offering, $3B in non-FDIC backed notes: Morgan Stanley also announced that it intends to offer approximately $3B in aggregate principal amount of senior notes in a registered public offering. The notes will not be guaranteed by the FDIC

WFC (24.76): Wells Fargo announces $6B secondary offering through JPMorgan, Wachovia

IPI (26.14): Intrepid Potash (IPI) reports Q1 EPS $0.33 vs Reuters $0.27.

STT (37.83): State Street upgraded to buy from neutral at Bank of America Merrill Lynch: Target increased to $50 from $40.