This is an article from Bloomberg News, Tuesday, April 8, 2008 which explains in laymen's terms the situation that the major lenders find themselves dealing with. It's a quick read.
Citigroup, Wells Fargo May Fuel Recession by Curtailing Lending
By Mark Pittman, Alan Katz and David Mildenberg
April 8 (Bloomberg) -- Bank holding companies including Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. have the thinnest safety cushion against losses in seven years.
The margin may erode further in coming weeks. Credit ratings on $704 billion of bonds have been cut this year following the collapse of the U.S. housing market. Sheila Bair, chairman of the Federal Deposit Insurance Corp., said last week that the downgrades may compromise bank capital ratios enough that some of the largest institutions will no longer be considered well capitalized.
Falling below a regulatory benchmark that is intended to maintain a minimum level of capital to protect depositors against losses would subject banks to more scrutiny from regulators than they have ever experienced.
``This is a nightmare for the country,'' said William Isaac, who was chairman of the FDIC from 1981 to 1985. Banks will ``raise what capital they can, then they'll slow down their growth and stop lending, and what should be a mild recession becomes a much more serious one.''
The biggest danger to the economy is that to preserve their ratios, banks will cut off the flow of credit, causing a decline in loans to companies and consumers. Banks have already raised $136 billion in capital, based on data compiled by Bloomberg, and cut dividends. More stock sales and payout reductions are likely to follow, says analyst Meredith Whitney at Oppenheimer & Co.
`Institutional Panic'
The credit crunch has already cost the world's biggest financial companies about $232 billion and forced a government bailout of New York-based Bear Stearns Cos., the fifth-largest U.S. investment bank. The International Monetary Fund said last week that banks were in the worst financial crisis since the Great Depression.
``Banks have to maintain their ratios,'' said Dennis Santiago, chief executive officer of Institutional Risk Analytics, a Torrance, California-based research firm that monitors banking statistics. ``This is an institutional panic. At what point will consumers feel the panic? I don't know.''
The banks need to shore up the ratio of the value of their common stock, preferred shares, retained earnings and loss reserves to the total of risk-adjusted assets, which are affected by credit ratings. To be considered a ``well capitalized bank'' by U.S. regulators, an institution can't have more than 10 times its capital in risk-weighted assets. More than 99 percent of American banks qualify as well capitalized.
As a group, regulated banks had a total risk-based capital ratio of 12.79 percent at the end of last year, according to data compiled by Bloomberg. The figure was the lowest since 2000, before the last U.S. recession.
Citi's Ratio
Pittsburgh-based PNC Financial Services Group Inc.'s banking unit had a 10.24 percent total risk-capital ratio at the end of 2007, according to the FDIC. Cleveland-based National City Corp.'s banking unit had a ratio of 10.31 percent.
The holding companies for Citigroup, Bank of America and Wells Fargo have the lowest ratios in at least the five years that the Federal Reserve has been tracking the data.
Citigroup, based in New York, had stock, retained earnings and preferred shares in 2007 equal to 10.7 percent of its risk- weighted assets. That's down from 12.02 percent in 2005. Wells Fargo, based in San Francisco, was at 10.68 percent, down from 11.76 percent, and Charlotte, North Carolina-based Bank of America, 11.02 percent, down from 11.08.
By contrast, the average ratio for the nation's 66 biggest bank-holding companies was 11.63 percent. New York-based JPMorgan Chase & Co., the third-biggest U.S. bank holding company, had a ratio of 12.57 percent, up from 12.04 percent. The measurements are so important that JPMorgan obtained an exemption from the Fed last week so it could exclude from risk- weighted assets certain securities in the planned takeover of Bear Stearns.
`Big Concern'
Spokesmen for the 10 biggest bank holding companies, including Citigroup, Bank of America and Wells Fargo, declined to comment for this story, some citing rules restricting what they can say in the days leading up to financial reports. One factor affecting Bank of America's capital ratio was its October purchase of LaSalle Bank for $21 billion.
The FDIC's Bair said last week that ratings changes will probably lower bank capital ratios for some U.S. banks.
``It's a big concern,'' Blair said in an interview April 3. ``We are dealing with an unprecedented situation.''
How much commercial banks have already cut back on lending will be known in mid-April when most report earnings.
``All I know is the first-quarter reports are going to be pretty bad, and there's a lot more to come,'' said L. William Seidman, who was chairman of the FDIC from 1985 to 1991. ``Our experience was that if the economy got in trouble, it took at least a year for the banks to get into trouble.''
`When Tide Goes Out'
Fed Chairman Ben Bernanke described bank capital requirements in congressional testimony April 2 as ``the nub of the problem'' and said U.S. institutions had ``hunkered down'' and were lending less.
Falling below the required capital levels would also hinder banks' ability to take over other banks and raise deposit insurance rates, according to the FDIC and the Office of the Comptroller of the Currency.
``The important thing to remember about capital ratios is that they are minimums,'' said Ralph Sharpe, a lawyer at Venable LLP in Washington, who was director of the OCC's enforcement and compliance division from 1984 to 1994. ``In good times everybody looks good, but when the tide goes out, you see who is not wearing their bathing suit.''
Moody's Investors Service, Standard & Poor's and Fitch Ratings have lowered investment-grade ratings on more than 28,000 mortgage- and asset-backed securities since the first of the year. In March alone, more than $134 billion in such securities were downgraded enough to change risk weightings on bank balance sheets, according to data compiled by Bloomberg.
AAA Weighting
Banks are required to put different risk weightings on assets ranging from government notes to mortgage securities to corporate bonds and cash. A $100 million mortgage-backed security with an AAA or AA rating counts as $20 million for the bank's risk-adjusted asset total. Securities with top credit ratings are considered most likely to be repaid and count for less risk.
If the same security's rating fell to BBB+ on Fitch's or S&P's scale, the risk weighting would rise to 100 percent, or the full $100 million, because of an increased likelihood of default. When ratings companies differ on the grade given to a mortgage-or asset-backed security, regulators use the lowest one.
All corporate bonds have a risk weighting of 100 percent, no matter what their rating, because of their perceived risks, while cash and government securities carry no weight.
Maintain Ratio
At the end of last year, Citigroup, for instance, owned $552 billion of securities weighted at zero risk and $523 billion at 20 percent. It also held $320 billion with risk weightings of 50 percent and $881 billion at 100 percent, according to data filed with the Federal Reserve.
To maintain the ratio of 10 percent when a $100 million AAA security is dropped to BBB, a bank's needed capital would rise to $10 million from $2 million. An institution can raise the $8 million by selling stock or preferred shares. The bank can also compensate by selling the security, or cutting back on other lending.
Regulators focus on two more measures in gauging the health of financial institutions. Well-capitalized banks must have Tier One capital, which excludes subordinated debt and some preferred shares, of at least 6 percent of risk-weighted assets. Additionally, Tier One capital can't fall below 5 percent of total tangible assets, not adjusted for risk and excluding goodwill, or the extra value of acquired assets.
Investment banks, such as Goldman Sachs and Morgan Stanley, both based in New York, have different regulatory requirements and aren't subject to the same minimums.
`Potential Shortfall'
To bolster their capital ratios, banks have been raising money for months, including a $19 billion initial public offering of Visa credit cards, which was owned by a bank group.
Citigroup has so far been the biggest seeker of capital, generating $30.4 billion through the sale of shares, preferred stock and bonds convertible into equity. Chief Financial Officer Gary Crittenden said in January that the program ``addresses this potential shortfall under multiple scenarios.''
A risk-based capital ratio lower than 10 percent automatically pulls a bank into a lower regulatory category, called ``adequately capitalized.'' By itself, that wouldn't set off runs on teller windows, said Isaac, the former FDIC chairman. Individual depositors will rely on FDIC insurance to protect their savings while larger business clients will examine the overall health of the bank, Isaac said.
``It does affect bragging rights,'' Isaac said. ``A lot of banks want to be able to say `we're well-capitalized by regulatory standards.''
Fremont General, National City
Smaller banks, which own fewer mortgage-backed securities and do more direct real-estate lending, are already feeling the pain. Fremont General Corp., a former subprime mortgage lender, has until May 26 to generate new funds or find a buyer after it was deemed undercapitalized by regulators. Its total capital risk ratio was 9.21 percent.
National City is in talks to sell itself to KeyCorp, a rival bank that's also based in Cleveland.
The number of lenders on the FDIC's ``problem'' bank list rose to 76 on Dec. 31 from 50 a year earlier. In 1990, the total reached 1,500. Three FDIC-insured banks failed in 2007, the first since June 2004. The agency hired as many as 138 examiners for a division that manages shutdowns and liquidations of failed banks, agency spokesman Andrew Gray said.
To contact the reporters on this story: Mark Pittman in New York at mpittman@bloomberg.net; Alan Katz in Paris at akatz5@bloomberg.net; David Mildenberg in Charlotte, North Carolina, at 6587 or dmildenberg@bloomberg.net. Last Updated: April 8, 2008 00:01 EDT
By Mark Pittman, Alan Katz and David Mildenberg
April 8 (Bloomberg) -- Bank holding companies including Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. have the thinnest safety cushion against losses in seven years.
The margin may erode further in coming weeks. Credit ratings on $704 billion of bonds have been cut this year following the collapse of the U.S. housing market. Sheila Bair, chairman of the Federal Deposit Insurance Corp., said last week that the downgrades may compromise bank capital ratios enough that some of the largest institutions will no longer be considered well capitalized.
Falling below a regulatory benchmark that is intended to maintain a minimum level of capital to protect depositors against losses would subject banks to more scrutiny from regulators than they have ever experienced.
``This is a nightmare for the country,'' said William Isaac, who was chairman of the FDIC from 1981 to 1985. Banks will ``raise what capital they can, then they'll slow down their growth and stop lending, and what should be a mild recession becomes a much more serious one.''
The biggest danger to the economy is that to preserve their ratios, banks will cut off the flow of credit, causing a decline in loans to companies and consumers. Banks have already raised $136 billion in capital, based on data compiled by Bloomberg, and cut dividends. More stock sales and payout reductions are likely to follow, says analyst Meredith Whitney at Oppenheimer & Co.
`Institutional Panic'
The credit crunch has already cost the world's biggest financial companies about $232 billion and forced a government bailout of New York-based Bear Stearns Cos., the fifth-largest U.S. investment bank. The International Monetary Fund said last week that banks were in the worst financial crisis since the Great Depression.
``Banks have to maintain their ratios,'' said Dennis Santiago, chief executive officer of Institutional Risk Analytics, a Torrance, California-based research firm that monitors banking statistics. ``This is an institutional panic. At what point will consumers feel the panic? I don't know.''
The banks need to shore up the ratio of the value of their common stock, preferred shares, retained earnings and loss reserves to the total of risk-adjusted assets, which are affected by credit ratings. To be considered a ``well capitalized bank'' by U.S. regulators, an institution can't have more than 10 times its capital in risk-weighted assets. More than 99 percent of American banks qualify as well capitalized.
As a group, regulated banks had a total risk-based capital ratio of 12.79 percent at the end of last year, according to data compiled by Bloomberg. The figure was the lowest since 2000, before the last U.S. recession.
Citi's Ratio
Pittsburgh-based PNC Financial Services Group Inc.'s banking unit had a 10.24 percent total risk-capital ratio at the end of 2007, according to the FDIC. Cleveland-based National City Corp.'s banking unit had a ratio of 10.31 percent.
The holding companies for Citigroup, Bank of America and Wells Fargo have the lowest ratios in at least the five years that the Federal Reserve has been tracking the data.
Citigroup, based in New York, had stock, retained earnings and preferred shares in 2007 equal to 10.7 percent of its risk- weighted assets. That's down from 12.02 percent in 2005. Wells Fargo, based in San Francisco, was at 10.68 percent, down from 11.76 percent, and Charlotte, North Carolina-based Bank of America, 11.02 percent, down from 11.08.
By contrast, the average ratio for the nation's 66 biggest bank-holding companies was 11.63 percent. New York-based JPMorgan Chase & Co., the third-biggest U.S. bank holding company, had a ratio of 12.57 percent, up from 12.04 percent. The measurements are so important that JPMorgan obtained an exemption from the Fed last week so it could exclude from risk- weighted assets certain securities in the planned takeover of Bear Stearns.
`Big Concern'
Spokesmen for the 10 biggest bank holding companies, including Citigroup, Bank of America and Wells Fargo, declined to comment for this story, some citing rules restricting what they can say in the days leading up to financial reports. One factor affecting Bank of America's capital ratio was its October purchase of LaSalle Bank for $21 billion.
The FDIC's Bair said last week that ratings changes will probably lower bank capital ratios for some U.S. banks.
``It's a big concern,'' Blair said in an interview April 3. ``We are dealing with an unprecedented situation.''
How much commercial banks have already cut back on lending will be known in mid-April when most report earnings.
``All I know is the first-quarter reports are going to be pretty bad, and there's a lot more to come,'' said L. William Seidman, who was chairman of the FDIC from 1985 to 1991. ``Our experience was that if the economy got in trouble, it took at least a year for the banks to get into trouble.''
`When Tide Goes Out'
Fed Chairman Ben Bernanke described bank capital requirements in congressional testimony April 2 as ``the nub of the problem'' and said U.S. institutions had ``hunkered down'' and were lending less.
Falling below the required capital levels would also hinder banks' ability to take over other banks and raise deposit insurance rates, according to the FDIC and the Office of the Comptroller of the Currency.
``The important thing to remember about capital ratios is that they are minimums,'' said Ralph Sharpe, a lawyer at Venable LLP in Washington, who was director of the OCC's enforcement and compliance division from 1984 to 1994. ``In good times everybody looks good, but when the tide goes out, you see who is not wearing their bathing suit.''
Moody's Investors Service, Standard & Poor's and Fitch Ratings have lowered investment-grade ratings on more than 28,000 mortgage- and asset-backed securities since the first of the year. In March alone, more than $134 billion in such securities were downgraded enough to change risk weightings on bank balance sheets, according to data compiled by Bloomberg.
AAA Weighting
Banks are required to put different risk weightings on assets ranging from government notes to mortgage securities to corporate bonds and cash. A $100 million mortgage-backed security with an AAA or AA rating counts as $20 million for the bank's risk-adjusted asset total. Securities with top credit ratings are considered most likely to be repaid and count for less risk.
If the same security's rating fell to BBB+ on Fitch's or S&P's scale, the risk weighting would rise to 100 percent, or the full $100 million, because of an increased likelihood of default. When ratings companies differ on the grade given to a mortgage-or asset-backed security, regulators use the lowest one.
All corporate bonds have a risk weighting of 100 percent, no matter what their rating, because of their perceived risks, while cash and government securities carry no weight.
Maintain Ratio
At the end of last year, Citigroup, for instance, owned $552 billion of securities weighted at zero risk and $523 billion at 20 percent. It also held $320 billion with risk weightings of 50 percent and $881 billion at 100 percent, according to data filed with the Federal Reserve.
To maintain the ratio of 10 percent when a $100 million AAA security is dropped to BBB, a bank's needed capital would rise to $10 million from $2 million. An institution can raise the $8 million by selling stock or preferred shares. The bank can also compensate by selling the security, or cutting back on other lending.
Regulators focus on two more measures in gauging the health of financial institutions. Well-capitalized banks must have Tier One capital, which excludes subordinated debt and some preferred shares, of at least 6 percent of risk-weighted assets. Additionally, Tier One capital can't fall below 5 percent of total tangible assets, not adjusted for risk and excluding goodwill, or the extra value of acquired assets.
Investment banks, such as Goldman Sachs and Morgan Stanley, both based in New York, have different regulatory requirements and aren't subject to the same minimums.
`Potential Shortfall'
To bolster their capital ratios, banks have been raising money for months, including a $19 billion initial public offering of Visa credit cards, which was owned by a bank group.
Citigroup has so far been the biggest seeker of capital, generating $30.4 billion through the sale of shares, preferred stock and bonds convertible into equity. Chief Financial Officer Gary Crittenden said in January that the program ``addresses this potential shortfall under multiple scenarios.''
A risk-based capital ratio lower than 10 percent automatically pulls a bank into a lower regulatory category, called ``adequately capitalized.'' By itself, that wouldn't set off runs on teller windows, said Isaac, the former FDIC chairman. Individual depositors will rely on FDIC insurance to protect their savings while larger business clients will examine the overall health of the bank, Isaac said.
``It does affect bragging rights,'' Isaac said. ``A lot of banks want to be able to say `we're well-capitalized by regulatory standards.''
Fremont General, National City
Smaller banks, which own fewer mortgage-backed securities and do more direct real-estate lending, are already feeling the pain. Fremont General Corp., a former subprime mortgage lender, has until May 26 to generate new funds or find a buyer after it was deemed undercapitalized by regulators. Its total capital risk ratio was 9.21 percent.
National City is in talks to sell itself to KeyCorp, a rival bank that's also based in Cleveland.
The number of lenders on the FDIC's ``problem'' bank list rose to 76 on Dec. 31 from 50 a year earlier. In 1990, the total reached 1,500. Three FDIC-insured banks failed in 2007, the first since June 2004. The agency hired as many as 138 examiners for a division that manages shutdowns and liquidations of failed banks, agency spokesman Andrew Gray said.
To contact the reporters on this story: Mark Pittman in New York at mpittman@bloomberg.net; Alan Katz in Paris at akatz5@bloomberg.net; David Mildenberg in Charlotte, North Carolina, at 6587 or dmildenberg@bloomberg.net. Last Updated: April 8, 2008 00:01 EDT
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