STRESS TESTS

Banks Got Cheatsheet For Their "Stress Tests"

Bank of america, Citicorp, Federal Reserve, Fifth Third, Morgan Stanley, PNC, Sun Trust, WELLS FARGO

Banks Won Concessions on Tests

Fed Cut Billions Off Some Initial Capital-Shortfall Estimates;

Tempers Flare at Wells

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WALL STREET JOURNAL

By DAVID ENRICH, DAN FITZPATRICK and MARSHALL ECKBLAD

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.

Interactives: Compare Banks Tested

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Bank by Bank Findings

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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.

[fed changed estimates]

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.

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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.

—Robin Sidel and Maurice Tamman contributed to this article.

Big U.S. Banks Will Soon Disappear

AMERICAN EXPRESS, American International Group, Bank of america, Banks, Citigroup, Economy, FIFTH THIRD BANCORP, Goldman Sachs, JPMORGAN CHASE, METLIFE, Morgan Stanley, STRESS TESTS, US BANCORP, WELLS FARGO

Big US Banks May Be Headed For Extinction—And Soon

CNBC

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Posted By: Albert Bozzo | Senior Features Editor
CNBC.com
| 08 May 2009 | 02:30 PM ET

In the world of banking, too-big-to-fail may be in the process of morphing into too-big-to-exist.

After hundreds of billions in federal aid and even more in lost investment capital, both the government and investors may be ready for a big sea change.

The only question, for some, is how quickly it will happen.

“In the next few months, we’ll see the tacitly nationalized banks—Bank of America, Citigroup —sold off rapidly into pieces, turned into much smaller banks,” Sanders Morris Harris Group Chairman George Ball predicted on CNBC Thursday, adding the government wants to send a strong message, to “punish too-big-to-fail banks that have blotted their copy and not exonerate their management.”

“Five years from now, these banks will be broken up,” is how FBR Capital Markets bank analyst Paul J Miller sees it.

From Washington to Wall Street to Main Street, a dramatic change in conventional thinking appears to underway.

“Some institutions are too big to exist, because they are too interconnected,” Sen. Richard Shelby (R-Ala.) told CNBC earlier this week. “The regulators can’t regulate them.”

That conclusion became painfully obvious in the two faces of the financial crisis.

On one side, the federal government had to provide billions in aid —and on more than one occasion—to the likes of to Bank of America , Citigroup and the giant insurer AIG , which has its own lending unit, to prop them up.

On the other side, the failure of Lehman Brothers—which might have been averted with federal intervention—reverberated throughout the global economy.

Months later, the Obama administration and Congress now appear keenly focused on the dilemma and are expected to create legislation that will empower regulators to intervene in the affairs of big financial institutions and essentially wind down their operations in an orderly fashion with limited collateral damage to the economy. Such authority would also apply to investment banks tirned bank holding companies, such as Goldman Sachs .

“They need it and they’ll get it,” said Robert Glauber, who was a top Treasury official during the government rescue of the savings and loan industry two decades ago.

Regulatory reform is also likely to include new antitrust authority to block mega-mergers creating financial firms whose problems could adversely affect the overall system. Analysts say, if that’s the case, the government won’t want the too-big-to-fail companies of the past essentially hanging around.

Exactly how the government does that is unclear, but experts say there are ways without resorting to a heavy-handed approach such as nationalization.

“If once there is some kind of coherent policy toward systemic risk, whomever is managing that policy can start to make life difficult for an entity that is too big to fail,” says former S&L regulator and White House economist Lawrence White, at NYU’s Stern School of Business. “It wouldn’t upset if they were providing subtle nudges.

“The Fed doesn’t want them that big and might make them hold more capital,” suggests Miller.

Some speculate that any further government aid to certain firms might come with such strings attached.

Others say a fresh look at regulation will help the process and unveil the complex, diverse and, at times, incompatible operations of the bank holding companies and their commercial bank subsidiaries.

“They can’t assess the risks of the big banks,” says Frank Sorrentino, Chairman and CEO of North Jersey Community Bank, which recently acquired a failing bank in a transaction assisted by federal regulators at the FDIC.

Risk, or a disregard of risk, may also have factored into the decision-making of big bank executives, who assumed the too-big-to-fail doctrine would catch them if they fell, which the bailouts obviously did.

Small banks clearly have a financial interest in seeing the end of the big bank era, but that alone doesn’t undercut their arguments. In some cases it may be good for business, consumers and the overall marketplace.

“It’s an appealing idea to our clients because it will make them more competitive,” says Robert C. Schwartz, a partner at Smith, Gambrell & Russell, which represents big and small banks in the Southeast. “Changes may leave gaps for the regional banks and the community banks.”

“If the government does the right thing, it will be the private sector that forces these companies to do what they need to do for the benefit of their shareholders,” says Sorrentino, whose bank has $400 million in assets. (By contrasts, the 19 firms involved in the government’s recently completed stress tests have assets of $100-billion or more.)

Investors have clearly been focused on shrinking earnings and stock prices and what some consider diminished prospects for the future, even with a positive resolution to the financial crisis.

“I also think investors are going to realize that they’ll be low-single digit growth rates,” says Miller

Some analysts say recent events highlight a fundamental problem that has been somewhat ignored for years; the financial supermarket structure of the big institutions makes them difficult, if not, impossible to operate with great success.

“Investors will say,That business unit hidden in there; let’s spin that off,” says Sorrentino. “Either the regulators are going to force it or the shareholders are going force it.”