Banks Got Cheatsheet For Their “Stress Tests”

Banks Won Concessions on Tests

Fed Cut Billions Off Some Initial Capital-Shortfall Estimates;

Tempers Flare at Wells

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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

Bank by Bank Findings

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.

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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

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.”

Banks Keeping Mum on TARP Bailout Funds; Only Morgan Stanley Coming Clean

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Morgan Stanley Is One Bank That Cites a Loan From TARP Money

Other Financial Banks Including Goldman Sachs and CitiGroup Keep Mum on How They Are Using TARP Cash

By CHARLES HERMAN, DAN ARNALL, LAUREN PEARLE and ZUNAIRA ZAKI

ABC NEWS

Dec. 17, 2008—

Banks that were rescued with billions of dollars in public funds have, in most cases, refused to provide specifics about how they have used or intend to use the money.

ABC News asked 16 of the banks that have received money from the Treasury Department’s $700 billion Trouble Asset Relief Program the same two questions: How has your financial institution used the money, and how much has your financial institution allocated to bonuses and incentives this year?

To read the banks’ responses, click here.

Goldman Sachs reported Tuesday that it paid $10.93 billion in compensation for the year, which includes salaries and bonuses, payroll taxes and benefits. That is down 46 percent from a year ago. Goldman Sachs received $10 billion from the Treasury.

“Bonuses across Goldman Sachs will be down significantly this year,” a bank representative told ABC News. The spokesman refused to disclose the size of the bonus pool or how much of the compensation fund of $10.93 billion was planned for bonuses.

“We do not break down the components of compensation; however, most of that number was not bonuses,” he said. Goldman Sachs added, “TARP money is not being paid to employee compensation. It’s been and will continue to be used to facilitate client activity in the capital markets.”

Goldman Sachs has pointed out that seven of its senior executives were forgoing bonuses this year. The company also reported Tuesday that it lost $2.1 billion in the last quarter.

“It looks like Goldman Sachs is treating this as business as usual,” said compensation expert James Reda. “They are taking our taxpayer money. They should be able to account for that money.

“What’s missing from this report is the exact amount of bonuses that were paid,” said Reda. He later added, “They’re hiding the ball.”

Fred Cannon, chief equity strategist with Keefe Bruyette and & Woods, an investment bank that specializes exclusively in financial services, said, “It is difficult to say what the TARP funds are directly used for. In terms of compensation, while TARP funds may not directly pay for compensation, the funds do provide additional overall cash to the companies.”

When pressed for what the TARP money was being used for, Goldman Sachs replied that it is spent to “facilitate client activity in the capital markets.”

Only One Bank Cited a Loan It Made

Of the 16 banks that were contacted by ABC News and asked how they were spending the hundreds of billions of taxpayer dollars, only one bank pointed to a specific loan that it made with the cash. That was a $17 billion loan that Morgan Stanley made to Verizon Wireless.

Morgan Stanley, which received $10 billion from TARP, released its quarterly finances today. The bank announced a dramatic and larger-than-predicted $2.37 billion quarterly loss but an overall year-end profit of $1.59 billion. That was down 49 percent from last year. The bank’s stock price dropped 72 percent this year.

In response to an ABC News email request, Morgan Stanley public information officer Mark Lake confirmed that bonuses are down “approximately 50 percent.”

Besides the Verizon loan cited by Morgan Stanley, the banks declined to detail how they were using the federal funds.

“Tarp money doesn’t go into bonuses,” Lake said, in an email to ABC News.

Wells Fargo said that of the $25 billion it received, it “cannot provide any foward-looking guidance on lending for this quarter [and] Intend[s] to use the Capital Purchase Program funds to make more loans to credit-worthy customers.”

More typical was the generic response by the Bank of New York Mellon, which said of the fortune it had banked in public moneys: “Using the $3 billion to provide liquidity to the credit markets.”

Congress and fiscal watchdogs have been frustrated and upset that the banks do not have to account for the way they are spending these publicly financed bonanzas.

The U.S. Treasury has spent or committed $335 billion of the $700 billion in the TARP fund in an attempt to get banks back in the lending business and to unfreeze the nation’s credit markets.

Last week Congress was angered to learn that giant insurance company American Insurance Group, which received $150 billion in TARP cash to stay afloat, was paying more than $100 million in “retention bonuses” to 168 employees.

That revelation prompted Rep. Elijah Cummings, D-Md., to complain, “It’s absolutely and incredibly wrong that we don’t have more transparency.”

All the Banks That Got TARP Cash Indicate They Are Paying Bonuses

While several banks said that its top executives would skip bonuses this year or its compensation pool was smaller this year than in past years, all indicated that some end-of-year compensation was in the works.

When asked how much the banks were paying out in bonuses and whether TARP funds would be used to finance them, most of the banks did not make such a declaration.

“Incentive compensation not yet allocated,” was as far as JP Morgan Chase, which received $25 billion from TARP, would go.

Bank of America, which got $15 billion from TARP, said only, “Have reduced the incentive targets by more than half. Final awards have not been determined.”

State Street Bank ruled out using TARP to reward its top officers.

“Will not use any of the proceeds from the TARP Capital Purchase Program to fund our bonus pool or executive compensation,” the bank insisted.

Cannon said the banks are being very conservative with their money.

After reviewing the statements the banks provided to ABC News he said, “The banks are expressing good intention in line with the good intention of the program. However, the answers from the bank belie the current challenge; the economy is deteriorating rapidly and making good loans, with strong underwriting into an economy that is falling apart is very difficult.”

ABC News’ MaryKate Burke contributed to this report.

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Guess What? That Whole “Limit on Executive Pay” Thingy in Bailout is Bunk

Executive Pay Limits May Prove Toothless
Loophole in Bailout Provision Leaves Enforcement in Doubt

By Amit R. Paley
Washington Post Staff Writer
Monday, December 15, 2008; A01

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Congress wanted to guarantee that the $700 billion financial bailout would limit the eye-popping pay of Wall Street executives, so lawmakers included a mechanism for reviewing executive compensation and penalizing firms that break the rules.

But at the last minute, the Bush administration insisted on a one-sentence change to the provision, congressional aides said. The change stipulated that the penalty would apply only to firms that received bailout funds by selling troubled assets to the government in an auction, which was the way the Treasury Department had said it planned to use the money.

Now, however, the small change looks more like a giant loophole, according to lawmakers and legal experts. In a reversal, the Bush administration has not used auctions for any of the $335 billion committed so far from the rescue package, nor does it plan to use them in the future. Lawmakers and legal experts say the change has effectively repealed the only enforcement mechanism in the law dealing with lavish pay for top executives.

“The flimsy executive-compensation restrictions in the original bill are now all but gone,” said Sen. Charles E. Grassley (Iowa), ranking Republican on of the Senate Finance Committee.

The modification reflects how the rapidly shifting nature of the crisis and the government’s response to it have led to unexpected results that are just now beginning to be understood. The Government Accountability Office, the investigative arm of Congress, issued a critical report this month about the financial industry rescue package that said it was unclear how the Treasury would determine whether banks were following the executive-compensation rules.

Michele A. Davis, spokeswoman for the Treasury, said the agency is working to develop a policy for how it will enforce the executive-compensation rules. She would not say when the guidance would be issued or what penalties it might impose. But she said the companies promised to follow the rules in contracts with the department.

The final legislation contained unprecedented restrictions on executive compensation for firms accepting money from the bailout fund. The rules limited incentives that encourage top executives to take excessive risks, provided for the recovery of bonuses based on earnings that never materialize and prohibited “golden parachute” severance pay. But several analysts said that perhaps the most effective provision was the ban on companies deducting more than $500,000 a year from their taxable income for compensation paid to their top five executives.

That tax provision, which amended the Internal Revenue Code, was the only part of the law that contained an explicit enforcement mechanism. The provision means the IRS must review the pay of those executives as part of its normal review of tax filings. If a company does not comply, the IRS can impose a tax penalty. The law did not create an enforcement mechanism for reviewing the other restrictions on executive pay.

If a firm violates the executive-compensation limits, department officials said, the Treasury could seek damages, go to court to force compliance, or even rescind the contracts and recover the bailout money. “We therefore have all the remedies available to us for a breach of contract,” Davis wrote in an e-mail.

Legal experts said those efforts could be complicated if the Treasury outlines the penalties after companies have received bailout money. David M. Lynn, former chief counsel of the Securities and Exchange Commission‘s division of corporation finance, said courts have sometimes placed limits on the government’s ability to impose penalties if there was no fair warning.

“Treasury might find its hands tied down the road,” said Lynn, who is also co-author of “The Executive Compensation Disclosure Treatise and Reporting Guide.”

Congressional leaders are also concerned that the Treasury might simply choose not to enforce the rules or be unwilling to impose financial penalties that could further weaken a firm and send the economy deeper into a tailspin.

The Bush administration at first opposed any restrictions on executive pay, congressional aides said. The original three-page bailout proposal presented to lawmakers in September contained no mention of such limits. “Treasury was pretty clear that they thought doing this exec-comp stuff would limit the effectiveness of the program,” said a Democratic congressional aide involved in the negotiations, who, like others interviewed for this story, spoke on condition of anonymity. “They felt companies might not take part if we put in these rules.”

Congressional leaders disagreed. By the morning of Saturday, Sept. 27, the final day of marathon negotiations on the bill, draft language relating to taxes and containing the enforcement provision applied to all companies participating in the bailout programs, Democratic and Republican congressional aides said. But then Treasury Secretary Henry M. Paulson Jr. and his deputies began pushing for the compensation rules to differentiate between companies whose assets are purchased at auction and those whose assets or equity are purchased directly by the government, the aides said.

Congressional leaders from both parties thought Paulson wanted the distinction for extraordinary cases like American International Group, which the government seized in September. He wanted to be able to push executives out of companies that the government controlled and have the flexibility to bring in strong new executives, said one senior congressional aide.

“The argument that they were making at the time is that the direct investment was going to be used only in circumstances where the company was AIGed, so to speak,” said a senior Democratic congressional aide.

Davis, the Treasury spokeswoman, confirmed that the Treasury pushed to place fewer restrictions on executives at companies receiving capital infusions, but she gave a different explanation. She said many of those firms are more stable and are being encouraged to participate in the bailout to strengthen the overall system. “The provisions for failing institutions should come with more onerous conditions than those for healthy institutions whose participation benefits the entire system,” she said.

Lawmakers agreed to the Treasury’s request that the measure apply only to executives at companies whose assets were bought by the government through auctions. In the executive-compensation tax section, a new sentence saying that eventually was inserted.

Meanwhile, Paulson repeatedly told lawmakers that he did not plan to use bailout funds to inject capital directly into financial institutions. Privately, however, his staff was developing plans to do just that, Paulson acknowledged in an interview.

Although lawmakers hailed the rules as unprecedented new limits on executive pay, several were unhappy that the law was not stricter.

Under pressure from Congress, the Treasury issued regulations in October on executive compensation and applied the tax-deduction limits to all companies receiving bailout funds, although the legislation did not require it for firms that received direct capital injections. But the Treasury failed to issue guidelines requiring the IRS or any other agency to enforce the rules, and it also failed to explain how the restrictions would be enforced.

The Treasury’s regulations also instructed firms to disclose more compensation information to the Securities and Exchange Commission. But officials at the SEC do not think they have the authority to force companies to disclose the kind of pay information required by the bailout law, according to people familiar with the matter, though they hope companies will cooperate. John Nester, an SEC spokesman, declined to comment.

Senators on the Finance Committee have expressed concern to Paulson and are now considering whether they should amend the law to apply the enforcement mechanism to all firms participating in the bailout.

First Presidential Debate | September 26, 2008 | Complete

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