STT State Street Corporation

By Ryan Tracy 

WASHINGTON -- U.S. regulators are preparing to notify some of the largest U.S. banks, including J.P. Morgan Chase & Co., that they have submitted flawed plans detailing how they would handle a potential bankruptcy, according to people familiar with the matter.

The move, which could come as soon as this week, would raise the prospect of higher capital requirements or other regulatory sanctions for some of the institutions, and call into question whether the firms remain "too big to fail" without a taxpayer bailout.

At least half of the eight American banks labeled "systemically important" by global regulators are expected to receive a harsh verdict on their "living wills" that they were required to submit under rules crafted since the financial crisis aimed at preventing another bank bailout, these people said.

The long-awaited verdict by the Federal Reserve and Federal Deposit Insurance Corp. is not yet final and could change, but regulators are putting the finishing touches on their feedback to the firms and will make their findings public soon, these people said.

The Fed's governing board was set to hold a closed meeting Tuesday afternoon to discuss the matter, one of the people said.

Representatives for the Fed, FDIC and J.P. Morgan declined to comment.

J.P. Morgan has previously said its living will is credible and that it has a "fortress balance sheet" that would prevent it from ever needing to tap taxpayers for help in a crisis. "We will be vigilant and will never take such a high degree of risk that it jeopardizes the health of our company....this is a bedrock principle," Chief Executive James Dimon said in his recent shareholder letter.

The adverse findings would mean J.P. Morgan and other firms will have to rewrite their bankruptcy strategies to address issues regulators have identified, or face sanctions, such as being required to hold higher levels of capital, which restricts borrowing and protects against losses -- but can also eat into profitability. If they fail to submit credible strategies repeatedly over a period of years, regulators could force them to divest certain assets.

In addition to J.P. Morgan, regulators have significant concerns about the bankruptcy strategies of the two so-called trust banks in the group: Bank of New York Mellon Corp. and State Street Corp., according to people familiar with the matter. Regulators have also been considering whether Bank of America Corp. should receive an adverse verdict, these people said.

Representatives for Bank of New York, State Street and Bank of America had no immediate comment.

Citigroup Inc. was expected to receive a positive finding from regulators, these people said.

A Citigroup spokesman had no comment.

Details about the other three American banks covered by the process -- Goldman Sachs Group Inc., Morgan Stanley and Wells Fargo & Co. -- couldn't be confirmed.

The expected verdicts do not mean the regulators believe the banks face any imminent danger of going out of business. Rather, the whole exercise was designed to start with the premise that each might one day face such extreme distress and show how they would respond. The bankruptcy strategies also don't take into account the fact that regulators could use other methods to avoid bailouts, including using the FDIC's authority to take over and liquidate a failing firm.

Regardless of what regulators say when they release their findings, however, the decisions are likely to feed big-bank critics across the political spectrum who say the government needs to take drastic action to reduce the size and influence of large Wall Street banks.

The regulators' rulings are likely to stir controversy, both among banks and among political critics who see the whole living-wills process as an example of postcrisis regulatory overreach. House Republicans Tuesday released a report from the Government Accountability Office that criticized the Fed and FDIC for a lack of transparency in handling living wills. The congressional watchdog said in its report that "may weaken public and market confidence" in the plans "and limit the extent to which the regulators can be held accountable for their decisions."

The agencies said in a letter in response to the report that they are "committed to enhancing public disclosure" in the living-will process.

Under the 2010 Dodd-Frank law, the eight U.S. banks designed as crucial to the broader financial system must file living wills showing they have a credible strategy to go through bankruptcy without causing a broader economic panic or needing help from taxpayers, one of many provisions in the law designed to prevent a repeat of the 2008 bailouts.

Four foreign-owned U.S. banks, including units of Barclays PLC, Credit Suisse Group AG, Deutsche Bank AG, and UBS Group AG, are also expected to receive feedback on their bankruptcy strategies this week, but regulators have been less concerned about those firms because a requirement that they organize all their U.S. operations under one holding company doesn't take effect until the summer.

The firms first received individual feedback on their bankruptcy strategies in 2014, when all but one of them, Wells Fargo, came up well short of regulators' expectations. They resubmitted the plans in July 2015 and have been waiting for feedback since.

In 2014, regulators issued only a general public statement describing shortcomings in the firms' plans. This year, regulators are expected to release specific information about problems at individual firms, rather than lumping the group together, people familiar with the matter said. One option on the table, these people said, is releasing redacted versions of the private letters that regulators send to firms detailing the feedback -- an outcome that Fed Chairwoman Janet Yellen hinted at during recent congressional testimony.

The language regulators use will be crucial. The Fed and FDIC have been preparing to determine that a majority of the eight U.S. firms, including J.P. Morgan, have living wills that either aren't credible, or don't facilitate an orderly resolution, people familiar with the matter said. Resolution is regulatory jargon for unwinding a failing firm.

Dodd-Frank says that when regulators make that determination, they must give firms a chance to fix deficiencies that regulators identify, "including any proposed changes in business operations and corporate structure to facilitate implementation of the plan."

The firms would then have a chance to resubmit their living wills, perhaps after a year. If those new plans again fail to demonstrate that the banks could credibly go through an orderly bankruptcy, regulators can impose further sanctions such as higher capital requirements or restrictions on growth or activities. Two years after the initial sanctions are imposed, regulators have the power to force firms to divest assets or operations that are deemed obstacles to an orderly bankruptcy.

The decisions may arrive as investors are already focused on the financial conditions and strategies of the biggest banks. They are reporting first-quarter earnings this week. J.P. Morgan kicks off Wednesday, followed by Bank of America and Wells Fargo on Thursday, and Citigroup on Friday. Investors and analysts anticipate a quarter driven heavily by turbulent trading and energy exposures, but a rebuke from regulators on living wills could also dominate conversations.

Once the firms receive the letters from regulators, they will be taking a close look at whether the Fed and FDIC have identified problems that are fixable without significant changes to their businesses. It is possible that regulators could identify problems that don't require a significant reorganization, such as deficiencies in the computer models firms use to predict the amount of cash they would need during a bankruptcy.

Write to Ryan Tracy at ryan.tracy@wsj.com

(END) Dow Jones Newswires

April 12, 2016 17:06 ET (21:06 GMT)

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