STT State Street Corporation

By Ryan Tracy 

WASHINGTON -- Regulators ordered five huge U.S. banks to make significant revisions to their so-called living wills by Oct. 1 or face potential regulatory sanctions, a stern warning that will fuel criticism the firms are "too big to fail."

J.P. Morgan Chase & Co., Wells Fargo & Co., Bank of America Corp., Bank of New York Mellon Corp., and State Street Corp. were found by the Federal Reserve and the Federal Deposit Insurance Corp. to have plans for a possible bankruptcy that don't meet the legal standard laid out in the 2010 Dodd-Frank law, which requires that firms have credible plans to go through bankruptcy at no cost to taxpayers.

They said those firms had until October to present plans regulators find acceptable, or the agencies or regulators could impose higher capital requirements, restrictions on growth or activities, or other sanctions.

Bank stocks, however, rallied in premarket trading, led by J.P. Morgan, which reported smaller-than-expected declines in earnings and revenue for the first quarter despite difficult trading conditions.

The regulators split in their assessments of Goldman Sachs Group Inc. and Morgan Stanley. The FDIC said that Goldman Sachs's plan didn't meet the legal standard, while the Fed didn't give that negative assessment.

The two regulators took the opposite stance on Morgan Stanley. The Fed "identified a deficiency" in Morgan Stanley's plan that it said didn't meet the legal standard, but the FDIC didn't go that far, the agencies said in a news release.

Citigroup Inc. was the only firm whose plan wasn't rejected by both agencies, though the Fed and FDIC said the firm's plan had "shortcomings that the firm must address" by July 2017.

The living wills had been submitted by the eight U.S. banks that had been deemed "systemically important financial institutions," or SIFIs, that are seen as being so large that their distress could put the economy at risk.

The agencies "are committed to carrying out the statutory mandate that systemically important financial institutions demonstrate a clear path to an orderly failure under bankruptcy at no cost to taxpayers," said FDIC Chairman Martin Gruenberg in a statement Wednesday. "Today's action is a significant step toward achieving that goal."

Overall, the regulators were less harsh in their assessments on the Wall Street-focused firms than on the universal and commercial banks.

While officials say they are imposing a much-needed new caution on a financial system that collapsed eight years ago, critics say that the tight leash they have attached to the largest banks may be undermining the sector's recovery, imposing new rules that discourage lending, crimp market liquidity, and erode bank profitability.

John Dearie, acting chief executive of the Financial Services Form, a trade group representing all of the large banks' CEOs except Wells Fargo, issued a statement Wednesday describing the regulators' concerns as "technical shortcomings" that the industry is committed to address.

"No financial company should be considered too big to fail," he said.

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 verdicts from the regulators don't mean that they expect any of the banks are in imminent danger of going bankrupt. Indeed, other provisions of the regulatory safety net adopted since the 2008 crisis are intended to make such a calamity less likely, notably the separate exercise of annual "stress tests," where banks need to prove they could withstand a severe economic shock. The living wills are set up to examine whether, if banks still reach a perilous state despite have gone through the stress tests, they can go through bankruptcy without triggering a financial crisis, or requiring a taxpayer bailout.

Regulators' explanations for their conclusions on the living wills varied by firm, and the agencies released letters describing their findings addressed to each firm's chief executive. The letters were partially redacted, and also detailed positive progress each firm has made toward a credible bankruptcy strategy.

In general, the problems included what regulators called insufficient analysis to prove the bankruptcy strategies could go off as planned, as well as what they said was inadequate progress toward reducing the firms' complexity and making them easier to break apart or wind down if necessary without taxpayer help.

On a conference call with reporters Wednesday, senior officials at the agencies said they believed the firms could address regulators' concerns by October, though doing so could require difficult choices that the firms might not otherwise make to run their businesses efficiently during normal times.

They noted that the regulators have said they expect the firms to be thinking about how they would handle their own failure "on a continual basis" as they make daily decisions about how to structure and fund their operations.

J.P. Morgan "has made notable progress in a range of areas," the agencies said, but "has key vulnerabilities that could undermine the feasibility of the plan" related to its estimated need for cash, or liquidity, in a crisis and its vast structure of legal entities.

Wells Fargo, which had previously received more positive feedback than other firms, was found to have made "material errors...that undermine confidence" in its preparedness for bankruptcy.

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

(END) Dow Jones Newswires

April 13, 2016 08:58 ET (12:58 GMT)

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