-
There is little question that banks are in a better position than they were just a few short years ago. But is more capital, or even an awful lot of capital, enough capital? And if so, what basis of measurement would one use to prove it?
February 14
To hear a lot of bank executives lately, dividend increases have moved from an aspiration to a near certainty.
These executives, and even many analysts, say that systemic risks to major commercial banks are dwindling and that most of these banks will pass the Federal Reserve's pending round of capital tests with flying colors.
But some lawmakers and regulators remain skeptical, arguing the industry has not come that far that fast. Exhibit A for these doubters is the fact that the Federal Deposit Insurance Corp. is still on the hook for $270 billion of bank debt.
Brad Miller, D-N.C.,
"A significant part of it is TLGP, and I understand that at the FDIC they are concerned about allowing banks to reduce their capital while there are still very substantial TLGP debts outstanding," he said in an interview Monday.
According to the Fed's November 2010 letter outlining the capital plans that the banks tested under the Supervisory Capital Assessment Program had to submit, repaying the Troubled Asset Relief Program and other government-guaranteed instruments is a prerequisite to greater dividends or similar capital adjustments.
TLGP debt "would not be considered in this evaluation of U.S. government investments," the letter said. However, bank holding companies' capital plans, it said, "should be consistent with their liquidity plans to address repayment of debts scheduled to mature over the 24-month planning horizon."
Miller's concerns extend beyond the possibility that dividend payments would increase risk to the FDIC.
"There is a great deal of uncertainty over the liability of the banks," he said, citing difficult-to-measure threats from investor and homeowner litigation, shaky second-lien portfolios, risks of further macroeconomic turbulence and discrepancies between bank accounting and mark-to-market principles.
"The less capital they have, the less they would be able to deal with financial shocks," Miller said.
Fed officials, however, appear to be confident that the banks' outlook is sufficiently clear to provide grounds for a potential decision to let certain banks release capital.
"The criteria provide a common, conservative approach to ensure that [bank holding companies] hold adequate capital to maintain ready access to funding, continue operations and continue to serve as credit intermediaries, even under adverse conditions," the Fed's November letter said.
Some observers questioned whether it is possible to have high a degree of certainty about the appropriateness of capital levels.
"Like so many of the actions the Fed and Treasury have taken over the past year, from the regulation and supervision, this is more about instilling confidence than demonstrating fundamental strength in our banking system," said Josh Rosner, managing director of the research firm Graham Fisher & Co. "I fear we are back to the same regulatory capture in the division of supervision at the Fed that brought us to crisis."
Hand-wringing over capital levels runs contrary to the prevailing mood among bank executives and analysts, who have made it clear that they view the capital tests as an almost ceremonial prelude to the resumption of dividends by the stronger of the SCAP banks.
"We believe the Federal Reserve will give early approval to a handful of the SCAP banks to increase their dividends, possibly within two weeks," Gerard Cassidy of RBC Capital wrote last week. If that happens, he said, it will touch off a run in bank stocks. "We believe 30% payout ratios will be the new normal with buybacks eventually being utilized to manage excess capital levels later in 2011 and/or early 2012."
Jamie Dimon, the chairman and chief executive of JPMorgan Chase & Co., who has previously said that he would like a 35% dividend payout, insisted on Tuesday that the resumption of sizable dividend payments would, if anything, make the banking system safer. If banks have to figure out what to do with a surfeit of capital, he said, both institutions and the regulators might come to regret it.
"In 12 months we may be looking at a lot of capital and maybe it will make some people do some stupid things," he said.
Not every institution that submitted capital plans is seeking approval for immediate payouts, but even relative stragglers are operating under the assumption that dividend increases are around the corner. Bank of America Corp. will not be included in the first round of capital tests to be concluded in March, but its executives have predicted that the Fed will approve a "modest" dividend increase in the second half of the year.
A person familiar with the FDIC's position said the regulator was not opposed outright to the prompt issuance of increased dividends and saw merit to the capital tests. But while the final decision on dividends is up to the Fed, the FDIC is pushing for an emphasis to be put on TLGP debt.
Though the guaranteed bonds, some of which remain outstanding for several years to come, are an extremely cheap source of financing (yields on some are just above 2%), the FDIC would like to see banks replace them sooner with longer maturity debt — or at least not start draining off excess capital until they have done so.
After citing the specific TLGP debts outstanding for Wells Fargo & Co., JPMorgan Chase and Bank of America, Miller's letter asserts that "it seems hard to justify reducing the capital of banks without considering the continued government support that banks with outstanding guarantees enjoy. Any reduction in capital levels at such banks with outstanding TLGP guarantees may put the FDIC at greater risk than when the TLGP guarantees were issued."
Rosner was more blunt.
"I don't know how you call a capital restoration plan that ignores $270 billion of low-cost, government-guaranteed debt that matures in the next two years to be credible," he said.
The Fed had no immediate response to the letter on Tuesday. But Federal Reserve Gov. Daniel Tarullo said in January that the central bank would be conservative when evaluating dividend or share-buyback proposals.
"In the run-up to the crisis, a lot of financial institutions continued to pay dividends, even as their capital position was eroding," Tarullo told CNBC. But given "normalization" in the system, it was time to consider the requests of SCAP banks that could prove they are in a strong capital position, he said.
"Having said that, we are going to proceed in a conservative fashion," Tarullo added.
