WASHINGTON — When regulators decided Tuesday to flunk Wells Fargo's resolution plan, it marked the first time a major U.S. bank has been sanctioned for not having a strategy to resolve itself in bankruptcy.
The Federal Reserve and Federal Deposit Insurance Corp. issued a series of letters in April to five banks — Bank of America, BNY Mellon, JPMorgan Chase, State Street and Wells Fargo — whose living wills were judged "not credible" by the agencies in April. Those five banks were given specific instructions on how to improve their plans and were instructed to resubmit the living wills by October 1.
But on the second try, the results of which were released Tuesday, only Wells was determined not to have made the cut — another body blow to its already battered reputation. Here are four takeaways from what the determination means for Wells, the other globally systemically important banks, the regulators and the living wills process overall.
Regulators Appear to Prefer a Certain Resolution Strategy
Several observers noted that Wells' failure seems to have demonstrated — even if only tacitly — that a single point of entry resolution strategy may be favored method for a bank to show that it has a credible plan for resolving itself in bankruptcy.
Senior agency officials maintained Tuesday that this was not the case on a conference call with reporters, arguing that the agencies involved are agnostic about precisely how a bank chooses to resolve itself.
But in practice, of the eight GSIBs required to submit living wills, six had espoused single point of entry strategies, which—as the name implies — rely on a single point of entry for regulators if the bank gets into trouble. In the process of resolving regulators' complaints, Bank of New York Mellon opted to embrace that strategy, leaving Wells the only bank to go in a different direction—and the only one to fail.
Karen Shaw Petrou, managing partner with Federal Financial Analytics, said that it's easy to put two and two together.
"The agencies really do favor single point of entry," Petrou said, noting that though the agencies maintain that they are neutral on resolution strategy, "they're not."
Another source familiar with the living wills process who could not be quoted on the record said the multiple-point-of-entry strategy is clearly a source of consternation for the Fed and FDIC, and it shows in the ways in which the agencies criticized Wells' resolution plan.
"If you read between the lines they're actually criticizing that strategy. Wells is the only firm that's utilizing it," the source said. "That's part of the criticism being leveled at them. They haven't provided through their structure that they can be separated in an MPOE strategy."
Robert Burns, the managing director of Chain Bridge Partners and former deputy director for complex financial institutions at the FDIC, agreed that while Wells got dinged for its approach, there were other aspects of the multiple entry plan — such as the separation and sale of Wells into regional units — that regulators approved.
"It seems that they were being evaluated regardless of what the strategy was," Burns said.
Regulators Did Not Drop the Hammer
The regulators were not as harsh as they could have been, targeting only Wells' ability to expand into foreign markets — historically not its bread and butter — and acquire nonbanks. Wells has been on a tear lately in acquisition of those kinds of firms, but some said the sanctions amount to a slap on the wrist.
"Living wills have become a regulatory exercise in failure," said Paul Miller, a managing director and head of financial institutions research at FBR Capital Markets. "No bank has been penalized for failing. So until [regulators] hurt big banks in the pocketbook, they're not going to put resources in place to get the living wills done. Until we see sanctions where it hurts investors, or CEOs can't get bonuses until they pass living wills, then investors won't care."
Some said the election helped to blunt the impact of the news.
"This could have been far more consequential if Hillary Clinton had won the White House. Clinton said during a debate that she would demand that any bank that failed its living will submission be broken up," wrote Jaret Seiberg, an analyst with Cowen Washington Research Group. "President-elect Donald Trump did not make a similar pledge, which suggests the risk of a structural change is minimal."
Petrou noted that the sanctions were somewhat surprising because by and large, Wells has the most traditional and least complex business lines of any of the GSIBs.
"I don't know that they were made an example of," Petrou said. "It's just surprising result because they're the least complex of all the GSIBs."
Still, Regulators Are Generally Getting What They Want
On the whole, regulators are getting serious concessions on major issues related to structure and governance — especially considering the position the largest banks were in circa 2008.
"The most important thing in the credibility of the process is all of the changes that GSIBs have made to pass," Petrou said. "They've significantly restructured themselves."
Sen. Sherrod Brown, D-Ohio, who serves as the top Democrat on the Senate Banking Committee and who has been a leading critic of Wall Street, praised the findings, saying that it is "a reminder that Wall Street reform is working to rein in the megabanks" and that "we need watchdogs that will continue to impose tough rules and strong penalties to make banks simpler and safer, not the opposite."
Burns said the determination shows that the regulators mean business when it comes to living wills. The decision to impose further penalties next year — and even force divestments if the living wills remain unsatisfactory two years from now — shows that the regulators are willing to use the authority they have been given.
"Not only did the agencies show that they would continue to make adverse findings, but that they would take action," Burns said. "They showed that they are willing to use that authority and they signaled that they were willing to ramp up these restrictions."
Wells Had the Heaviest Lift
Regardless of today's outcome — and perhaps in part because of its use of a multiple strategy — Wells had the hardest job of any of the five GSIBs to get regulators to sign off on its living will. The regulators said as much in their April determinations, saying at the time that Wells' submission "call[s] into question the extent to which there was appropriate internal review and coordination with respect to the 2015 Plan prior to its submission."
One former FDIC official said that, taken in that context, the Wells determination is not very surprising.
"If you look at where Wells stood compared to the others back when the April letters were sent, it appears it had the higher hill to climb," the former official said. "That suggests that they may not have as many resources dedicated to the effort as the others."