Since the economy hit an iceberg in October, America’s biggest banks have felt a bit like shipwreck survivors: required to wear lifebelts provided by the government, despite complaints from some that they could have kept afloat on their own.
After much grumbling about the restrictions associated with this aid, the strongest banks are now back on shore. On June 9th ten banks-nine of which had undergone stress tests in April-were given the go-ahead to repay a combined $68 billion to the Troubled Asset Relief Programme (TARP). Though no list was published, the lucky lenders gleefully advertised their escape. They include three titans-JPMorgan Chase, Goldman Sachs and Morgan Stanley-as well as two regional banks, three custodians and two credit-card issuers.
The move was made possible by a recent market thaw that allowed relatively healthy banks to go on a capital-raising spree. Banks have-for now, at least-amassed enough equity to get by without having to offload their least liquid assets. Plans for a public-private partnership to buy up banks’ most troubled loans and securities have been largely put on ice.
We have been here before, say sceptics, only to see fresh capital fizzle as bad assets ate through balance-sheets. If markets tank again, they worry, some of the first repayers may even need a hugely embarrassing second handout. Officials counter that the banks were forced to raise substantially more capital than was required by the stress tests, to ensure an extra-plump cushion, and to show that they could raise at least some debt without government guarantees (albeit at elevated spreads).
The cushion may not be as padded as it looks, however. Also on June 9th, the Congressional Oversight Panel published a report that questioned the stress tests’ reliance on banks’ own data and their failure to capture the full risks in asset classes, particularly commercial property, that are only now going bad. The panel urged that the tests be repeated, since unemployment is expected to exceed the level envisaged in the worst-case scenario.
There are other reasons to keep the champagne on ice. Even the healthiest banks-including those that insist they never needed help-continue to rely on government assistance in the form of liquidity facilities, generous collateral rules and the like. The debt-guarantee scheme is due to expire in October but may be extended. Moreover, the TARP escapees have yet to learn the price they must pay to cancel the government’s warrants, which give it the right to buy common shares for ten years. JPMorgan Chase alone could have to stump up $2.6 billion, according to CreditSights, a research firm.
The banks are sure to face lots of new red tape, even outside the TARP-and even if, as seems likely, the government scales back the extent of the regulatory overhaul it is expected to unveil on June 17th. Firms considered too big to fail face tougher capital and liquidity rules. Under executive-pay rules set out on June 10th, banks needing multiple bail-outs, such as Citigroup, will fall under a new “special master” who can reject pay plans for senior employees. All TARP banks will be subject to bonus and golden-parachute limits. Those with no government capital will not face specific limits, but shareholders will have more of a say on pay, Congress willing, and regulators more leeway to alter pay policies.
The stragglers are naturally keen to join the first ten on dry land. They fear further stigmatisation now that the wheat has been formally separated from the chaff. A more specific concern is the loss of talent to ex-TARPers. One reason Morgan Stanley worked so hard to ensure its place in the first wave was the stomach-churning prospect of Goldman Sachs poaching its finest.
For those left behind, prospects vary. Wells Fargo (busy digesting Wachovia) and Bank of America (which has been choking on Merrill Lynch and Countrywide) will hope to be in the second wave of repayers, perhaps towards the end of this year.
At Citigroup, which will soon be 34% state-owned, things are even less comfortable. The Federal Deposit Insurance Corporation (FDIC), which is on the hook for $290 billion of Citi’s deposits as well as debt guarantees, is said to be unconvinced by Citi’s stress test, which identified a $5.5 billion capital hole. It is also pushing for a board and management shake-up to bring in more commercial-banking experience-Citi’s boss, Vikram Pandit, and some of his closest lieutenants cut their teeth in capital markets. Other regulators would prefer to leave the former quant to implement his belated turnaround plan. The tussle echoes bigger battles. The FDIC has locked horns with other agencies over who should be the new systemic-risk regulator and who should have authority to wind down failing non-banks.
The repayments will increase available TARP funds to $170 billion, reducing the likelihood of having to ask Congress for more money. Some may be used to pay down debt (or rather, to slow its growth), but Tim Geithner, the treasury secretary, wants to keep a healthy buffer to deal with surprises. He is also keen to “level the playing field” by helping smaller banks, which were largely overlooked during efforts to stabilise the giants. The groundwork has been laid, with the maximum they can request recently raised from 3% to 5% of assets, and the approval process streamlined.
Small banks are just as wary of the TARP stigma as larger rivals. But their woes are growing along with those of commercial property, to which the small fry are particularly exposed. In the very worst case, more than 2,000 community and regional banks-a quarter of the total-could fail or be forced to merge, reckons Institutional Risk Analytics, a research and ratings firm. Quite apart from the cost to the FDIC’s deposit-insurance fund, anything close to that would prove logistically overwhelming for regulators. So throwing lifebelts to smaller banks makes sense. But if things take another turn for the worse, the big ones could end up back in the water.