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Bank Regulators Pull Out All the Stops

Two subtle accounting moves made by federal regulators last week illustrate the lengths to which the government is pulling out all the stops to boost capital at and confidence in the nation's largest banks.

Two subtle accounting moves made by federal regulators last week illustrate the lengths to which the government is pulling out all the stops to boost capital at and confidence in the nation's largest banks.


Federal Reserve

said on Friday that financial holding companies would be allowed to include capital invested by the government, through its $250 billion plan to take

preferred equity

stakes in banks, in their Tier-1 capital ratios. Regulators on Monday said that warrants issued by banks to the Treasury, which are considered liabilities under generally accepted accounting principles, will also be considered capital.

Also late last week, federal bank regulatory agencies announced that institutions that took losses on

Fannie Mae



Freddie Mac


preferred shares as a result of the

government's takeover

of the two government-sponsored mortgage giants, would be allowed to write these losses against earnings. This will provide immediate tax benefits to many banks, boosting cash, since it means they won't have to carry the losses forward, hoping to use them to offset future gains.

JPMorgan Chase

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announced $1 billion in third quarter losses on Fannie and Freddie preferred shares. At the top federal corporate tax rate of 35%, the accounting change provides an immediate tax benefit of $350 million.

Wells Fargo

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announced third-quarter impairment charges of $480 million on investments in Fannie and Freddie.


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mentioned third quarter losses in GSE positions, but didn't specify the amounts.

Bank of America

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announced $350 million in losses on Fannie and Freddie preferred shares in the third quarter.

The Federal Deposit Insurance Corp. has made several moves to support banks' liquidity, starting with the temporary increase of its individual account deposit insurance limit from $100,000 to $250,000, through 2009. The FDIC followed up with an even stronger measure, the

temporary liquidity guarantee program

, which removed insurance limits on non-interest-bearing transaction accounts through 2009, and offered to guarantee newly-issued senior debt through June 2009, for a maximum of three years.

These and other moves taken by the Fed and European central banks seem to be helping to restore confidence credit markets. The three-month U.S. London interbank offered rate (Libor) dropped considerably to 4.05875%, from 4.41875% on Friday, according to the British Bankers association, as reported by the

Wall Street Journal

, meaning banks showed an increased willingness to lend to each other over that period. The one-month rate fell to 3.75125% from 4.18125% and the overnight rate fell to 1.5125% from 1.66875%, as it moved much close to the Fed's target rate of 1.5%.

Banks Still Reluctant to Lend

Despite the aggressive government action and recovery in Libor rates and signs of life in the commercial paper market, some banks remain cautious.

Merrill Lynch


CEO John Thain, who will be Bank of America's president of global banking when the merger is completed, said the $25 billion capital cushion Treasury is providing the soon-to-be combined organization is "just going to be a cushion," at least for the next quarter. House of Representatives Financial Services Chairman Barney Frank (D., Mass.) said he was "very disturbed" to hear "they're going to take the money and not lend more out. That is not acceptable."

Bank of New York Mellon

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CEO Robert Kelly made similar comments when discussing his company's $3 billion capital infusion from the Treasury, saying "This will just be something that in essence strengthens our balance sheet and I don't intend to be using it."

Treasury Secretary Henry Paulson on Monday urged banks not to sit on their hands as he laid out guidelines for the program through which the federal government will invest $250 billion in

preferred equity

stakes in banks.

"Our purpose is to increase confidence in our banks and increase the confidence of our banks, so that they will deploy, not hoard, their capital," Paulson said.

Some smaller banks have other reasons for hesitating to lend. CEO Richard Berg of Chicago-based Performance Trust Capital Partners says regulators zeal to be conservative is causing smaller community banks to shy away from lending to small and medium-sized businesses. For instance, regulators are requiring banks to mark down the value of commercial loans that were once considered solid, including some where the payments are still current, he says. Some of his customers are complaining regulators are "changing rules in the middle of the game." He also pointed out that bankers have no recourse if they disagree with regulators.

"The big banks aren't lending to each other since they are afraid of another

Lehman Brothers

," he says. "Smaller banks are afraid to lend to businesses, because they are getting hurt by the regulators."

Peter Davidson, CEO of financial services consulting company Brooks FI Solutions, agreed about the tougher supervisory environment. "Regulators have to think about what happens if they wind up sitting in front of a congressional committee, so they have to be more strict," he says.

Randy Marshall, managing director and leader of the U.S. financial services industry practice at risk management consultant Protiviti, said "the capital may provide an underlying degree of confidence." He went on to say, however, that smaller institutions are focusing on managing their credit risk and knowing their borrowers.

"It's probably unrealistic to expect the institutions to immediately turn on the spigot and push that excess funding and liquidity right into the market by opening up credit facilities," Marshall says.

Philip W. van Doorn joined Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.