The U.S. Federal Reserve's emergency lending programs, intended to thaw commercial paper and money markets, are also helping banks limit losses from some of their $4 trillion in off-the-books guarantees and loan commitments.
A Fed program to buy as much as $1.8 trillion of short-term debt from U.S. companies means they don't have to tap backup credit lines provided by banks, which would have forced JPMorgan Chase & Co.,Citigroup Inc. and other financial institutions to record the loans on their balance sheets and raise more capital. Another Fed program, with the acronym ABCPMMMFLF, aims to shore up the $1 trillion market for asset-backed commercial paper issued by off-the-books financing vehicles guaranteed by banks.
``The Fed's commercial paper programs avoided a mid-air collision,'' saidJosh Rosner, managing director of New York- based research firm Graham Fisher & Co. Having to deliver on the loan commitments ``would have caused a liquidity crunch'' for the banks that made them, he said.
The three-week-old program for commercial paper, or debt maturing in nine months or less, had $257 billion of loans outstanding as of Nov. 13, the Fed reported.
Ford Motor Co.'s financing unit, which uses a $16 billion commercial paper program to fund auto loans, sold about $4 billion of that to the Fed, according to a Nov. 7 regulatory filing. Doing so minimized draws from the $16 billion of bank credit lines backing up the commercial paper, the filing said. The credit lines are provided by 42 banks, including JPMorgan ($3 billion), BNP Paribas SA ($1.1 billion) and Deutsche Bank AG ($924 million), according to Ford Credit Auto Owner Trust, manager of the program for the Dearborn, Michigan-based company.
Torchmark, Chrysler
Torchmark Corp., a McKinney, Texas-based insurer, said on Oct. 23 it was relying on Fed financing instead of drawing on a $600 million credit line from JPMorgan, Bank of America Corp. and 12 other banks. Also using the Fed program are American Express Co., Chrysler Financial Corp. and General Electric Co., the biggest commercial paper issuer with $63 billion of backup credit lines provided by 70 financial institutions.
Another $76 billion of loans was outstanding under the Fed's Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (ABCPMMMFLF) set up Sept. 19 to help money funds raise enough cash to meet redemption requests. In that program, the Fed made risk-free loans to banks so they could buy asset-backed commercial paper from the money funds.
JPMorgan in New York, Bank of America in Charlotte, North Carolina, and Boston-based State Street Corp. have all participated, according to regulatory filings. Citigroup also used the facility, spokeswoman Danielle Romero-Apsilos said.
Crawl Back
New York-based Citigroup, the fourth-largest U.S. bank by market value, is the biggest administrator of asset-backed commercial paper programs, followed by Amsterdam-based ABN Amro Holding NV, JPMorgan, the No. 1 U.S. bank by market value, and Bank of America, the third-largest U.S. bank, according to data compiled by Asset-Backed Alert, which tracks the market.
If companies eligible for the Fed's commercial paper program had tapped their credit lines for the full $1.8 trillion, the banks would have had to set aside tens of billions of dollars against the loans. They also would have had to draw down their cash reserves, sell highly rated investments such as Treasury bills or crawl back to the Fed for additional financing, said Joe Scott, a banking analyst at Fitch Ratings in New York.
Tapping lines of credit ``would have been a big deal in terms of the total amount outstanding that would then have to be funded by the banks,'' saidTanya Azarchs, global research coordinator for financial institutions at Standard & Poor's in New York. Once loans and securities are added to the balance sheet, banks have to account for subsequent losses and writedowns in their earning statements.
Off-Books Assets
The 30 biggest U.S. banks hold about $1 of capital for every $11 of ``risk-weighted assets,'' a figure that encompasses assets both on and off the balance sheet, Scott said. Off-books assets get about half the risk-weighting as those on the books, which means banks are required to hold about half the capital.
Some banks already are so burdened with faulty mortgage investments that they might have become ``toast'' with the stress of additional capital requirements, Rosner said.
Since the financial crisis began last year, U.S. banks have had to raise more than $480 billion through sales of equity stakes and other assets to replenish coffers depleted by about $650 billion of writedowns and loan losses, according to data compiled by Bloomberg.
Fitch published a report last week saying that European banks may need as much as 80 billion euros ($100 billion) of extra capital to meet open credit lines to companies. No similar study has been done for the U.S., Scott said.
Liquidity Facilities
Banks abetted the growth of money markets by agreeing to provide liquidity facilities, or backstop funding, whenever mutual funds, corporate treasurers and other short-term debt investors backed away. Now the Fed is playing that role, offering loans that have caused the central bank's balance sheet to double in the past seven weeks to $2 trillion.
``Anything that enhances liquidity in the system as a whole will benefit all the parties to the system,'' said William Sweet, a former Fed staff attorney who's now a partner in Washington with Skadden, Arps, Slate, Meagher & Flom LLP. The Fed's new lending facilities may ``have an indirect positive effect on the banks by lessening their need to provide backup funding, which they do for all sorts of things in the economy,'' he said.
The indirect benefits add to the explicit support the U.S. government has provided to the country's financial institutions during the past two months. The Treasury Department is injecting $250 billion into banks, including JPMorgan, Bank of America, Citigroup, State Street and Wells Fargo & Co. On Oct. 14 the Federal Deposit Insurance Corp. said it would guarantee banks' newly issued debt.
Tapping Credit Lines
So far, the programs haven't halted the decline in financial stocks. The KBW Bank Index, which tracks shares of the 24 largest U.S. lenders, fell last week to a 12-year low.
Under U.S. accounting rules, banks don't include loan commitments -- typically letters of credit or the unused portion of credit lines -- on their balance sheets. When a company taps its credit line, the bank has to deliver the funds, and the loan gets recorded on the balance sheet.
Partly because the loan commitments are off the books, disclosure isn't standardized. JPMorgan has $407.8 billion of what it calls ``wholesale'' loan commitments, according to regulatory filings. Citigroup has $400.7 billion of ``commercial and other consumer'' loan commitments. Bank of America has $385.2 billion of ``loan commitments'' and Wachovia Corp. in Charlotte has $236.2 billion. San Francisco-based Wells Fargo, which is buying Wachovia, has $89.5 billion of ``commercial'' loan commitments.
Citigroup's Pain
Companies that can't qualify for the emergency Fed financing because their credit-ratings are too low have tapped backup bank lines to refinance their commercial paper. They include American Electric Power Co., a Columbus, Ohio-based utility, and appliance maker Whirlpool Inc.
Regulators never should have let banks back commercial paper programs to finance anything other than short-term obligations, such as inventory and payroll, Graham Fisher's Rosner said.
The potential for losses from off-balance-sheet assets was demonstrated last December, when Citigroup had to bring $59 billion of so-called structured investment vehicles back onto its balance sheet. Those assets are still haunting the bank, costing $2 billion in writedowns in the third quarter.
The Financial Accounting Standards Board, which sets U.S. bookkeeping rules, bowed to industry pressure in July when it agreed to delay by one year, to 2010, new rules that would have forced banks to pull more off-balance-sheet obligations back onto their books. The new rules apply to trusts used to package credit card loans into securities. Citigroup, JPMorgan and Bank of America alone have about $300 billion of these combined.
Unfreezing Markets
``With the capital issues in the financial services industry, the last thing you want to do is require more capital,'' said Scott Valentin, an Arlington, Virginia-based credit-card industry analyst for Friedman Billings Ramsey.
The Fed's efforts helped unfreeze the markets, bringing 23 straight daily declines in the London interbank offered rate, or Libor, that banks charge each other for borrowing dollars for three months. The rate serves as a benchmark from which many other loans are priced.
``To the extent that the Fed's actions bring down Libor, generally everybody benefits,'' said Roger Lister, chief credit officer of ratings company DBRS Inc. who worked as an economist with the Fed Bank of San Francisco during the savings and loan crisis in the 1980s. ``The banks are sort of in the middle.''
This isn't how it was supposed to work, Lister said.
Tender-Option Bonds
``Looking back, there wasn't enough clarity on the extent to which banks were providing a lot of liquidity lines that relied on all the markets behaving reasonably well most of the time,'' he said. ``Everything was fine as long as markets behaved reasonably well most of the time, which they didn't.''
Regulators need to do a better job of policing banks' off- balance-sheet commitments, said William Seidman, who was chairman of the FDICduring the savings and loan crisis.
``It's a matter of making sure that banking regulators look at potential and contingent obligations,'' Seidman said. ``They can tell banks, `If you want this, you've got to have more capital, or else you have to get rid of it.'''
The Treasury's capital infusions and the FDIC's debt guarantees also helped ease the burden of off-books commitments. That's because the jolt of confidence helped stabilize the market for so-called tender-option bonds, a type of municipal bond that comes with backup guarantees provided by the banks, said Matt Fabian, managing director and senior analyst atMunicipal Market Advisors, a Concord, Massachusetts-based research firm.
$7 Billion Inventory
The market convulsed in September after the bankruptcy of New York-based Lehman Brothers Holdings Inc. made buyers question the validity of the guarantees, he said.
``People had been pulling back because they had fears about the credit quality of the banks that are the liquidity providers,'' Fabian said. ``Once the federal government stepped in and was more assertive with directly assisting the banks, I think people generally have taken more comfort.''
Citigroup said in an Oct. 31 regulatory filing that its inventory of tender-option bonds swelled to $7 billion at the end of September from $1.1 billion at the end of June, as holders asked the bank to take them back. In October, Citigroup's inventory of the bonds fell back to pre-September levels as the market loosened up, said a person familiar with the situation who declined to be identified because the bank hasn't provided a public update.
Jeffrey Previdi, a senior director in the public finance unit of Standard & Poor's, said the Fed's actions have brought ``a little bit of return to normalcy'' in the tender-option bond market. ``But there are still some real issues concerning credit or liquidity providers and their strength.''
