Citigroup C and Bank of America BAC will need to raise more capital based on preliminary results of their government-run "stress tests" — unless they succeed in appealing the findings, according to two people familiar with the matter.
The banks are making their arguments to regulators, said these people, who spoke on condition of anonymity because they have been ordered not to discuss it. Among their points could be that regulators don't fully understand the banks' operations, they said.
But the companies face an uphill battle in convincing Fed officials, who privately released the results Friday, that the results are wrong, analysts said. They noted that the tests are supposed to be rigorous enough for the results to be widely accepted.
Shares of Bank of America and Citi each dropped more than 5%. Wells Fargo, U.S. Bancorp, Bank of New York Mellon and others also dipped. JPMorgan Chase, American Express and a few more of the 19 banks tested by the government traded slightly higher.
Investors have grown more concerned about regional banks with many risky loans on their books. Defaults on those loans could skyrocket in a worsening economy. Banks that carry such loans, including KeyCorp and SunTrust Banks, are likely to be asked to improve their capital reserves, according to analysts.
"It's not surprising there are some slaps on the wrist or calls for recapitalization," such as at Citi or Bank of America, said Simon Johnson, a former IMF chief economist now at Massachusetts Institute of Technology's Sloan School of Business. "It's in keeping with their overall strategy" of waiting out the banking system's problems, he said.
Federal Reserve officials told reporters Friday that all 19 banks that underwent stress tests will need to keep an extra buffer of capital reserves beyond what's now required, in case losses continue to mount. That would mean some banks will likely have to raise additional cash.
But the Fed stressed in a statement that a bank's need for more capital reserves to meet the requirements should not be considered a measure of the "current solvency or viability of the firm."
Fed officials held top-secret meetings with bank executives last week to give them preliminary findings of how each bank would fare if the recession got much worse. The banks can dispute their results this week.
They will receive the final test results Friday, and the government plans to announce the results next week. By law, the banks cannot publicize the results without the government's permission.
The results will determine the fates of the companies, which together hold one-half of the U.S. banking system's loans. Banks found to need more capital face several possibilities: The government could convert its stake in them to common shares, force them to raise money from investors or eventually release more funds from the Treasury Department's $700 billion financial bailout.
The banks' options are designed to ensure banks have enough cash to withstand the mounting loan losses they would absorb in a bleaker economy.
The news about Charlotte-based Bank of America and New York-based Citi was first reported in The Wall Street Journal Tuesday.
Bank of America declined to comment.
A Citi spokesman added that the bank is continuing with its plan to exchange debt for equity and shed assets as part of a program to further bolster its capital position.
Citi has reached a basic agreement to sell its Japanese brokerage unit, Nikko Cordial, to Sumitomo Mitsui Financial Group for 500 billion yen ($5.2 billion), according to The Nikkei business newspaper. Citi declined to comment on the potential sale of the unit.
Fed spokeswoman Michelle Smith on Tuesday declined to comment on Bank of America and Citigroup.
Treasury spokesman Andrew Williams said department officials would not comment on whether regulators told Bank of America and Citigroup they may need to raise more capital.
As executives of the nation's largest banks review their stress-test results, even the top performers are lobbying regulators to raise their scores before the numbers are finalized Friday.
For Treasury, the easiest way to bolster bank balance sheets is to convert the government's existing stake from preferred shares — a form of debt — into common shares that carry voting rights. This would help Treasury avoid returning to Congress for more bailout money — a request lawmakers are likely to rebuff.
If the test showed a bank would need more money to endure a much worse recession, regulators will force it to meet higher standards for capital reserves, to offset possible future losses.
Banks deemed to have enough capital may learn whether they'll be permitted to repay billions of dollars the government injected into them last fall, analysts and officials said. Most large banks have said they want to repay the money to escape executive compensation limits and other obligations.
Shares of Citigroup fell 16 cents, or 5.2%, to $2.91% in late-afternoon trading. Bank of America shares lost 69 cents, or 7.7%, to $8.23.
Contributing: AP Economics Writers Jeannine Aversa and Martin Crutsinger