Debate Over Extension of Bush Tax Cuts Continues
On Thursday, House Majority Leader Steny Hoyer (D-MD) and House Speaker Nancy Pelosi (D-CA) told House Democrats at a closed door meeting that the House would vote before the end of the year on extending the Bush tax cuts for only those individuals making less than $250,000. However, even if such a measure were to pass in the House, it is unclear whether the Senate will agree to such a vote. There is still the possibility the bill may not pass the House if Republicans are able to successfully pass a procedural response, known as a “motion to recommit,” that could force a House vote on a full extension of the Bush tax cuts. According to sources, Pelosi told President Barack Obama that House Democrats remain firmly committed to allowing Bush-era tax cuts to expire for earners making more than $250,000, which complicates the Administration’s efforts to reach a compromise with Senate Republicans.
Preview of Next Year’s Budget Fight
On Thursday, Senate Minority Leader Mitch McConnell (R-KY) announced he would oppose the pending omnibus appropriations bill, thereby forcing Congress to rely on another stopgap “continuing resolution,” or CR, to keep the government funded after December 3. If Republicans are able to block the omnibus spending bill, it would set up an early confrontation with President Obama next year over not just deeper cuts from the President’s 2011 budget but also tens of billions of dollars in rescissions from prior years. The White House is seeking a continuing funding resolution which would cover the next 10 months of the fiscal year until September 30, which would deny House Republicans a chance to defund portions of the healthcare bill early next year.
Fed Orders New Stress Tests
On Wednesday, the Federal Reserve announced plans to scrutinize the nation’s top 19 banks through a second round of “stress tests.” The stress tests will require the bank-holding companies to submit capital plans by early 2011 proving their capability to handle losses under a set of conditions including “adverse” economic conditions and continuing real estate-related problems. In its announcement, the Fed said it plans to perform such reviews regularly on an ongoing basis. The Fed also issued a road map for banks that want to raise dividends or buy back stock saying firms must show they have sufficient capital in place to withstand losses over the next two years and demonstrate an ability to satisfy new, tougher global capital requirements.
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On June 1, 2009, the Federal Reserve announced the standards that the Federal Reserve would apply in determining whether the nineteen largest bank holding companies (the “Stress Test” participants) would be permitted to redeem their outstanding TARP Capital Purchase Program securities.
Under the TARP Capital Purchase Program, an institution may seek to redeem the TARP investment at any time, subject to the approval of the institution’s primary federal regulator. While institutions were initially limited in their ability to redeem the TARP investment during its first three years, Congress removed that limitation under the American Recovery and Reinvestment Act of 2009. As of June 1, 2009, 20 institutions had redeemed their TARP Capital Purchase Program investment. The Federal Reserve announced that the first approvals for redemptions by the nineteen largest bank holding companies would be announced during the week of June 8, 2009.
On May 7, 2009, the Federal Reserve released its Overview of Results of the Supervisory Capital Assessment Program (or Stress Test). The headlines regarding the Stress Test Results are likely to emphasize that ten of the 19 participating institutions are required to collectively raise $74.6 billion in new common equity, as follows:
- American Express – $0
- Bank of America – $33.9 billion
- BB&T – $0
- Bank of New York Mellon – $0
- Capital One – $0
- Citigroup – $5.5 billion
- Fifth Third – $1.1 billion
- GMAC – $11.5 billion (of which $9.1 billion must be new Tier 1 Capital)
- Goldman Sachs – $0
- JP Morgan – $0
- Key Corp – $1.8 billion
- MetLife – $0 billion
- Morgan Stanley – $1.8 billion
- PNC Financial – $0.6 billion
- Regions – $2.5 billion (of which $400 million must be new Tier 1 Capital)
- State Street – $0
- SunTrust – $2.2 billion
- U.S. Bancorp – $0
- Wells Fargo – $13.7 billion
Notably, only GMAC and Regions have to raise new Tier 1 Capital in order to satisfy the Stress Test standards; the remaining entities may satisfy the standard by converting existing Tier 1 Capital (such as the TARP Capital Purchase Program funds) into Common Stock. This can be accomplished under the TARP Capital Assistance Program without any additional use of Treasury funds.
For the 8,000+ banks that did not participate in the Stress Test, however, the takeaways are likely to be completely unrelated to the actual results encountered by the 19 participating institutions.
In advance of releasing the “Stress Test” results (scheduled for 5:00pm on Thursday, May 7, 2009), the Treasury and the federal banking regulators released a joint statement about the Supervisory Capital Assistance Program on May 6, 2009. The joint statement also includes information about the process that will be used for institutions desiring to redeem their TARP Capital Purchase Program Preferred stock.
A few key points about the Stress Test:
- The government intends to announce, for each of the 19 institutions individually and in the aggregate, estimates of: losses and loss rates across select categories of loans; resources available to absorb those losses; and the resulting necessary additions to the capital buffers.
- Any of the 19 needing to raise capital will be given until June 8, 2009 to develop a detailed capital plan, and until November 9, 2009 to implement that plan.
- As part of the capital plan, an institution may apply for Mandatory Convertible Preferred under the TARP Capital Assistance Program, and may convert its existing TARP Capital Purchase Program Preferred shares into the Capital Assistance Program Convertible Preferred shares.
- “Smaller financial institutions generally maintain capital levels, especially common equity, well above regulatory capital standards.”
- Accordingly, the government does not intend to expand the Stress Test beyond the initial 19 bank holding companies (at least officially).
- The Treasury reiterates that the TARP Capital Assistance Program is available to other institutions on the same terms and conditions applicable to the 19 Stress Tested banks. The Treasury intends to process applications received “in an expedient manner.” (No discussion is made of when or if term sheets will be made available for non-publicly traded institutions to participate in the Capital Assistance Program.
On April 24, 2009, the Federal Reserve published a white paper describing the process and methodologies employed by the federal banking supervisory agencies in their forward-looking capital assessment of large U.S. bank holding companies. The white paper is thin on new details, but does provide a base for understanding the stress tests being undertaken of 19 bank holding companies with total assets in excess of $100 billion.
Purpose and Effect of the Stress Tests
The stress tests are designed as the first part of the Capital Assistance Program to demonstrate which institutions the government believes will need to raise additional capital. If a stress test demonstrates that an institution requires additional capital, the institution will be required to enter an agreement to issue convertible preferred securities to the U.S. Treasury in an amount sufficient to meet the capital shortfall under the TARP Capital Assistance Program. Each such institution will then be permitted up to six months to raise private capital in public markets to meet their capital needs, and would be able to cancel the obligation to the government without penalty. Participants would also be given the opportunity to convert their existing TARP Capital Purchase Program preferred stock into the convertible preferred stock to be issued under the TARP Capital Assistance Program (such a conversion would not affect the institution’s Tier 1 capital, but could affect the institution’s tangible common equity and their dividend obligations).