WSJ: Banks Won Concessions On Tests

Banks Won Concessions On Tests
Fed Cut Billions Off Some Initial Capital-Shortfall Estimates; Tempers Flare At Wells

By David Enrich, Dan Fitzpatrick and Marshall Eckblad, WSJ | 9 May 2009

The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining. In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

The overall reaction to the stress tests, announced Thursday, has been generally positive. But the haggling between the government and the banks shows the sometimes-tense nature of the negotiations that occurred before the final results were made public. Government officials defended their handling of the stress tests, saying 'they were responsive to industry feedback while maintaining the tests' rigor'.

When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed's 'exaggerated' capital holes. A senior executive at one bank fumed that the Fed's initial estimate was "mind-numbingly" large. Bank of America was "shocked" when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.

At least half of the banks pushed back, according to people with direct knowledge of the process. Some argued the Fed was underestimating the banks' ability to cover anticipated losses with revenue growth and aggressive cost-cutting. Others urged regulators to give them more credit for pending transactions that would thicken their capital cushions.

At times, frustrations boiled over. Negotiations with Wells Fargo, where Chairman Richard Kovacevich had publicly derided the stress tests as "asinine," were particularly heated, according to people familiar with the matter. Government officials worried San Francisco-based Wells might file a lawsuit contesting the Fed's findings.

The Fed ultimately accepted some of the banks' pleas, but rejected others. Shortly before the test results were unveiled Thursday, the capital shortfalls at some banks shrank, in some cases dramatically, according to people familiar with the matter. Bank of America's final gap was $33.9 billion, down from an earlier estimate of more than $50 billion, according to a person familiar with the negotiations.

A Bank of America spokesman wouldn't comment on how much the previous gap was reduced, though he said it resulted from an adjustment for first-quarter results and errors made by regulators in their analysis. "It wasn't lobbying," he said. Wells Fargo's capital hole shrank to $13.7 billion, according to people familiar with the matter. Before adjusting for first-quarter results and other factors, the figure was $17.3 billion, according to a federal document.

"In the end we agreed with the number. We didn't necessarily like the number," said Wells Fargo Chief Financial Officer Howard Atkins. He said the company was particularly unhappy with the Fed's assumptions about Wells Fargo's revenue outlook. At Fifth Third Bancorp, the Fed was preparing to tell the Cincinnati-based bank to find $2.6 billion in capital, but the final tally dropped to $1.1 billion. Fifth Third said the decline stemmed in part from regulators giving it credit for selling a part of a business line.

Citigroup's capital shortfall was initially pegged at roughly $35 billion, according to people familiar with the matter. The ultimate number was $5.5 billion. Executives persuaded the Fed to include the future capital-boosting impacts of pending transactions. SunTrust Banks Inc. also persuaded the Fed to significantly reduce the size of its estimated capital gap to $2.2 billion, after identifying 'mathematical errors' in the Fed's earlier calculations, according to a person familiar with the matter.

PNC Financial Services Group Inc., saw a capital hole materialize at the last minute. As recently as Wednesday, PNC executives were under the impression they wouldn't need to find any new capital, according to people familiar with the matter. Thursday morning, the Fed informed PNC that it had a $600 million shortfall. Regulators said other banks also were told they needed more capital than initially projected.

The Fed's findings were less severe than some experts had been bracing for. A weeklong rally in bank stocks continued Friday, with the KBW Bank Stocks index surging 10%. Investors were especially relieved by the relatively small capital holes at regional banks. Shares of Fifth Third soared 59%, while Regions Financial Corp.'s $2.5 billion deficit led to a 25% leap in its stock.

With the stress tests, government officials were walking a fine line. If the regulators were too tough on banks, they risked angering their constituents and spooking markets. But if they were too soft, the tests could have lost credibility, defeating their basic confidence-building purpose. All the back-and-forth is typical of the way regulators traditionally wrap up their examinations of banks: Regulators often present preliminary findings to lenders and then give them time to respond.

The process can result in changes to the regulators' initial conclusions. Some of the stress-test revisions, for instance, were made to account for the beneficial impact of the industry's strong first-quarter profits. On Friday, some analysts questioned the yardstick, known as Tier 1 common capital, that regulators chose to assess capital levels. Many experts had assumed the Fed would use a better-known metric called tangible common equity.

According to Gerard Cassidy, an analyst with RBC Capital Markets, the 19 banks' cumulative shortfall would have been more than $68 billion deeper if the government had used the latter metric, which accounts for unrealized losses. Federal officials said their projections reflected the most comprehensive analysis ever conducted of the industry. The test results showed that the 19 banks faced a total of $599 billion in losses over the next two years under the government's worst-case, 'Depression-like' scenario.

The Fed directed 10 banks to add a total of nearly $75 billion to their capital buffers to insulate themselves from potential losses. Banks pressed ahead on Friday with plans to fill their 'capital holes' by tapping public markets. Wells Fargo raised $7.5 billion in stock through a public offering.

The bank originally planned to raise $6 billion, but expanded the offering, which was valued at $22 a share, due to robust demand. Shares of Wells Fargo rallied $3.42, or 14% to $28.18. Morgan Stanley, which is facing a $1.8 billion capital hole, raised $4 billion by selling stock. Shares of Morgan rose $1.06, or 4%, to $28.20.

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Banks Need At Least $75 Billion In Capital

By Deborah Solomon, David Enrich and Damian Paletta, WSJ | 7 May 2009

The Federal Reserve directed at least seven of the nation's biggest banks to bolster their capital levels by $75 billion while effectively blessing the stability of six others, marking for the first time a bold line between some of the nation's stronger and weaker banks.

Financial markets seemed to shrug off news of the capital shortfalls. Stocks of banks under duress rose dramatically and the Dow Jones Industrial Average rose 101.63 points by 4 p.m. trading, Wednesday, to close at 8512.28, a four-month high. In Tokyo Thursday morning, stocks were up 4.2%, boosted by financial shares. Some investors said the news was less negative than many feared.

Others held out the idea that many banks would be able to boost their capital without having to seek fresh government funds. The stress tests— designed to examine individual banks' ability to withstand future losses— helped alleviate the near-panic that investors felt at the beginning of the year as many worried some banks might have to be nationalized. One possible impediment to luring back private capital is lingering unease about the tests' rigor. Perhaps adding to such jitters, the Fed backtracked from its early estimates of some banks' losses.

In addition, it isn't clear what happens to hobbled regional banks that could have a hard time finding extra capital. Many are facing a deluge of bad loans to finance residential and commercial properties. Regions, based in Birmingham, Ala., is among a handful of the tested banks without any privately held preferred shares that it could convert into common stock to boost its capital buffer, according to Deutsche Bank. That leaves it with a narrow range of options beyond turning to the government for aid.

"The stress test gets us a lot closer to the bottom," said Trabo Reed, Alabama's deputy banking superintendent. "But the job isn't finished." Final results of the government's tests will be released Thursday after the close of trading and are expected to include a wealth of information about the industry's longterm health.

"I think this will be a confidence-instilling announcement," Federal Deposit Insurance Corp. Chairman Sheila Bair told a Senate panel Wednesday. "There will be additional needs for capital buffers for some institutions, but I think there will be mechanisms to do that within the next six months." The moves mark the beginning of a new phase for both the banking sector and the Obama administration. One reason investors and depositors fled large banks several months ago was uncertainty as to whether the institutions were even solvent, a problem the tests were designed to address.

The question now is whether the stronger banks can stand on their own feet and how well the weaker banks can recover. Until this point, the Bush and Obama administrations had tried to paint all banks equally, a posture designed to promote investor confidence as financial markets tottered. Now, some of the stronger banks will be permitted to repay funds borrowed from the government under its Troubled Asset Relief Program (TARP) and escape the related restrictions on compensation and dividend payments.

White House spokesman Robert Gibbs declined to rule out the possibility that the stress tests could lead the government to push out top executives at the weaker banks. The results could also propel the break up of some of the country's largest institutions into smaller, more manageable pieces. Citigroup and Bank of America have already begun shedding assets.

The testing process "does end what I would call the 'convoy' or 'herd' period where the government tried to keep everyone looking pretty much the same," said Arthur Wilmarth, a banking-law professor at George Washington University Law School. "Now they are going to have to say, in fact, some banks are better off than others." Banks are being told to boost their capital not because they are in trouble, but because regulators think they don't have a big enough 'buffer' to continue lending if the economy worsens in coming months.

Administration officials continue to believe many banks will be able to add to their capital without tapping the TARP's remaining $109.6 billion. They are optimistic much of the money will come from private investors, selling assets or offloading bad debt to a program set up by the Treasury. Those that can't tap private markets would be encouraged to replenish their coffers through a novel form of capital known as "mandatory convertible preferred" shares. Banks could apply for new funds from the government by agreeing to sell these preferred shares to the Treasury.

Banks could also swap the government's existing preferred stakes, received in exchange for TARP funds, for this new type, which would convert into common equity only if the bank posts losses in the future. That would allow the U.S. to recapitalize banks without controlling them. By keeping the investments as preferred stakes, at least for the time being, the government would remain a passive investor, helping it defer tricky questions about how deeply it would engage in banks' daily operations.

Bank of America intends to outline its strategy Thursday, according to people familiar with the matter. It maintains it has a number of options and doesn't need government capital. It doesn't agree with all of the Fed's findings and intends to spell out those differences, these people said. One option would be to convert about $33 billion in private preferred shares into common stock. It also is exploring the sale of business units such as private bank First Republic and asset manager Columbia Management, according to people familiar with the situation.

Those businesses could collectively fetch $4 billion, estimates analyst David Hendler of CreditSights Inc. About $8 billion could be raised with a partial sale of its stake in China Construction Bank. The company also believes it may outperform the government's projections, which would reduce its burden over time. If these moves don't fill the hole, Bank of America could convert the government's existing $45 billion investment into common stock or mandatory convertible preferred stock.

One question mark hanging over the tests is whether they will be perceived as tough enough. From the start, some economists and bank analysts argued that the Fed's worst-case economic scenario was overly rosy. Moreover, since the Fed informed banks of the preliminary test results, the government appears to have softened its estimates somewhat as the banks pushed back.

Among other things, regulators accepted banks' bullish arguments about their profit outlooks. The Fed initially planned to use banks' lackluster 2008 revenues as a jumping-off point to predict future incomes, according to people familiar with the matter. But many big banks logged robust first-quarter profits and argued that should serve as the "run rate" for the stress-test period.

Any bank needing more capital will have until June 8 to develop a plan and until Nov. 9 to implement it. The banks must also review their management and assure regulators that leadership has "sufficient expertise and ability," to manage through the current environment.

— Dan Fitzpatrick, Maurice Tamman and Robin Sidel contributed to this article.

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19 Banks Compared: Early Estimates

By Stephen Grocer

Results of the stress test [have been] trickling out. So far not too many surprises. As expected J.P. Morgan Chase and American Express don't need to raise fresh capital. Regions Financial does, though exactly how much is unclear. Below is a chart tracking who needs capital and who doesn't. Deal Journal will update the list as more results of the stress test come in:

Institution	Needs Capital?	Amount Needed (Value in Billions)
American Express	No	0
Bank of America	Yes	$33.9
Bank of New York Mellon	No	0
BB&T	No	0
Capital One	No	0
Citigroup	Yes	$5.5
Fifth Third	Yes	$1.1
GMAC	Yes	$11.5
Goldman Sachs	No	0
J.P. Morgan Chase	No	0
KeyCorp	Yes	$1.8
MetLife	No	0
Morgan Stanley	Yes	$1.8
PNC Financial	Yes	$0.6
Regions Financial	Yes	$2.5
State Street	No	0
SunTrust	Yes	$2.2
U.S. Bancorp	No	0
Wells Fargo	Yes	$13.7