Fed announced on Monday surprising new criteria necessary for the big banks to repay TARP.
Some of the additional Fed conditions require specific banks to raise capital beyond what stress tests results previously demanded—and banks are scrambling to comply.
Banks will stagger back to health in the months ahead, but ongoing share dilution and government inference will likely dampen the Financials sector's future performance relative to broader markets.
Indiana Jones fans know there's no such thing as an easy escape. Routes are filled with constant twists and dangers, and even when safety seems assured, a giant boulder or flash flood suddenly appears. America's big banks may feel like they're starring in a summer blockbuster, given the muddled path and nasty surprises greeting those eager to repay TARP.
Post-stress tests, most big banks finally glimpsed the light at the end of the TARP tunnel. Even those deemed to be in weaker standing had no problems raising additional capital, as was required by stress test results. Of course, that would have been too easy, and the Fed announced on Monday surprising new criteria necessary for the big banks to repay TARP.
Bank holding companies must now meet four outlined conditions besides other TARP-shrugging requirements: 1) Show paying back loans will not reduce lending activities, 2) show repayment will not reduce capital reserves below levels set by regulators, 3) prove ability to sell new shares of common stock to demonstrate money can be raised from investors, and 4) prove ability to issue debt without backing by government guarantee.
Some of the additional Fed conditions require specific banks to raise capital beyond what stress tests results previously demanded—and surprised banks are scrambling to comply. The new criteria may delay weaker banks' ability to repay TARP, and raising capital through common stock sales will further flood the market with Financials shares—further diluting shareholder value. As we've mentioned, the government can't simultaneously help and punish banks and expect a smooth recovery.
It may look like nothing but snake pits and dark chasms, but there is hope. Some 20 small banks have already paid or received approval to repay TARP. And for the big boys, the Fed said an initial set of applications will be approved next week. This latest Fed whimsy might be annoying and could prolong some banks' pain, but it's not a death knell.
The fact banks have had little difficulty raising billions in additional capital over the past few weeks shows they're not nearly as imperiled as was widely feared. Banks will stagger back to health, but ongoing share dilution and government interference will likely dampen the Financials sector's future performance relative to broader markets—at least in the near term. Perhaps a reason to be less bullish on Financials, but no reason not to expect stocks overall to begin a new bull market surge.