After Losses, Banks Do Damage Control
Wednesday, April 30, 2008
NEW YORK -- In a conference call this month on Citigroup's earnings, analysts asked whether the firm would need to raise money to offset mounting losses. Since last year, Citigroup had come up with $35 billion in new capital, and now the bank's executives were being cagey about whether they needed more. They said only that they felt "very good" about their capital levels.
The analysts got a different answer a few days later. Last week, Citigroup sold $6 billion in preferred stock to help further shore up its balance sheet after losses from the subprime mortgage meltdown.
That effort is one in a spate of similar moves by banks -- often made with the urging of their regulators -- as massive losses on bad loans have shrunk the capital of financial firms, threatening to leave them in a precarious state and further hamper their ability to continue making loans. In recent weeks, as financial institutions have announced grim first-quarter results, one after another has unveiled plans to raise billions of dollars from private-equity firms, large shareholders and other institutional investors.
For instance, Bank of America, the second-largest U.S. bank by assets, behind Citigroup, issued $4 billion of preferred shares on Thursday after it reported a third straight quarter of declining profits. The previous week, J.P. Morgan Chase, the nation's third-largest bank, raised $6 billion in its first preferred-share issuance this year. In the meantime, Wachovia, National City and Washington Mutual all said they would cut their dividends and seek multibillion-dollar capital infusions as they wrote down the value of assets and set aside billions of dollars for expected losses from a variety of loans.
Smaller banks have also joined in on the action as losses from mortgage-backed securities on the books of Wall Street firms have spread to consumer and business loans held by commercial banks across the country. In recent weeks, Provident Bank of Baltimore, Colonial BancGroup of Alabama and East West Bancorp, which caters to the Chinese American community, announced plans to raise capital by offering new shares and selling bonds.
Banks raise capital to ensure they have enough money to repay depositors and investors and to continue making loans. These firms can increase their capital levels in various ways, including issuing stock or cutting dividends, but each comes at a cost. Issuing new shares, for instance, can dilute the value of stock already held by shareholders.
Federal regulators have been pressing the banking industry, in public comments and private conversations with specific firms, to increase their capital levels. In some cases, regulators have pushed the banks to raise more capital than they had originally planned, according to one official. Both Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson Jr. have recently emphasized in public remarks that banks must raise more capital, while Fed Governor Kevin M. Warsh told an economic policy forum this month that banks "should not hesitate to pare their dividend and share-repurchase programs to strengthen their balance sheets."
These comments came after the Federal Deposit Insurance Corp. sent letters last month to the banks it regulates, stressing the importance of strong capital and loan loss allowance levels. The letters also cited the FDIC's increased concern for "recent weakness in the housing and construction and development markets" and institutions with concentrations in commercial real estate loans. The FDIC regulates more than 5,000 state-chartered banks and savings institutions.
"We were starting to see more credit issues and more losses . . . and we made it clear that it was imperative to repair the balance sheets," John Dugan, who heads the Office of the Comptroller of the Currency, said in an interview. His agency supervises about 1,700 national banks and federal branches of foreign banks. "We're going from a period of exceptionally benign credit conditions to a period where credit losses are clearly on the rise in a number of different categories of assets. And to get ready for that, capital and increased loan loss reserves are the best buffer," he said.
Adequate capital is crucial for banks, which need to maintain high enough levels to meet their obligations. Beyond that, banks also need capital so they can lend to consumers and businesses, providing credit that fuels the economy.
"You can not have healthy economic growth without having banks able and willing to provide loans," said Bernard Baumohl, managing director of the Economic Outlook Group. "Right now, banks are not in a position to provide loans to the degree that it would help the economy. Many institutions have simply shut their lending windows or they have significantly raised their standards to provide loans."
Just a year ago, banks had such little concern about capital that some were actually using their profit to buy back shares. In the first four months of 2007, U.S. banks raised $984 million through issues of preferred and common stock, according to SNL Financial. That figure surged to $71.5 billion this year.
Analysts said even more efforts to raise capital are likely as economic conditions worsen and banks are forced to take further losses.
"The fact that big banks like Washington Mutual are running out to raise capital just tells you how bad it really is," said Stephanie Hall, a senior analyst at Gradient Analytics. "I think we'll continue to see this trend, particularly at banks with high credit risk concentration in the hardest-hit states like California and Florida."
Regulators said that more than 99 percent of the banks they oversee were still well capitalized but added that capital cushions were shrinking, approaching what analysts call worrying levels at some institutions. As long as banks remain healthy, regulators cannot force them to raise capital. But as their financial position deteriorates, regulators can impose tighter restrictions, such as compelling banks to adopt plans for restoring capital.
For now, regulators said they largely wanted to see banks shore up their weakened balance sheets while markets were still receptive and before further credit problems make raising capital even more difficult and costly.
"When you fill up your gas tank, it's full. It can drop down to a little above half full, and you'd still say it was full, but it's a lot closer to not being full -- so that's where we are," said Timothy T. Ward, a deputy director at the Office of Thrift Supervision, which regulates savings banks.
Gerard Cassidy, bank analyst at RBC Capital Markets, worries that door may not be open for long. "Today the private-equity players and the large institutional shareholders -- they're all eager to participate," he said. "If the economy weakens sufficiently and the credit problems become a lot worse, that window will slam shut and then the banks will have to try to survive on their own or they'll end up in the arms of the U.S. government."