Regulators relaxed capital requirements and other criteria in 2009, allowing the largest financial institutions to repay Troubled Asset Relief Program bailouts before they should have, according to an audit released this week. Between October 2008 and December 2009, the Treasury Department sent $204.9 billion to 707 institutions through the Capital Purchase Program in exchange for preferred stock and warrants. Roughly 80% if the CPP investments went to 17 banks subject to a stress test conducted by the Federal Reserve. The banks would not be allowed to repay the TARP funds for three years unless they met certain requirements. Then Treasury Secretary Henry Paulson said the banks would need to wait in order to restore confidence in the financial industry and calm markets. But in the audit, the Special Inspector General for TARP said the banks “complained of a stigma associated with their participation in the program” and pushed for an early exit. The American Recovery and Reinvestment Act of 2009 eliminated the three-year waiting period. Two months after enactment, the Fed released the results of its stress tests and issued new requirements to exit TARP, which focused on capital standards and their ability to issue common stock. Soon after, nine of the 17 banks quickly repaid, including JPMorgan Chase (JPM), Goldman Sachs (GS), Morgan Stanley (MS) and the Bank of New York Mellon (BK). The others, including Bank of America (BAC), Wells Fargo (WFC) and Citigroup (C), requested an immediate exit anyway and began pushing back against regulators, according to SIGTARP. In November 2009, the Fed issued more guidance, allowing the remaining eight banks to repay once they issued at least $1 in new common equity for every $2 of TARP funds repaid. “Federal banking regulators relaxed the November 2009 repayment criteria only weeks after they were established, bowing at least in part to a desire to ramp back the Government’s stake in financial institutions and to pressure by institutions seeking a swift TARP exit to avoid executive compensation restrictions and the stigma associated with TARP participation,” SIGTARP said. BofA, Wells and Citi repaid TARP in December 2009 with only Citi satisfying the “1-for-2” rule. SIGTARP concluded by not enforcing this rule, regulators missed an opportunity to further strengthen the banks’ capital bases. The conclusion is especially illuminating considering the ongoing search for capital at some banks, especially at BofA. The banks persuaded regulators that the market would not support the mass influx of common stock issuance. According to the audit, Treasury even urged Wells to expedite its repayment plan. Roughly $49.1 billion in new common stock flooded the market, and Citi later complained that the influx of Wells Fargo stock “sapped demand” away. “Whether these institutions exited TARP with a strong and high quality capital structure sufficient to absorb their own losses and survive adverse market conditions without further affecting the broader financial system remains to be seen,” SIGTARP said. In a letter sent to SIGTARP in response, Scott Alvarez, general counsel for the Fed, said each firm that repaid TARP showed Tier 1 capital increased substantially and final decisions were done in coordination with all banking agencies. In another letter to the SIGTARP, John Walsh, the Acting Comptroller of the Currency, strongly disagreed with the audit’s conclusion and reiterated that relaxing the “1-to-2” rule “resulted from strong concern that the market would not bear the full amount of the equity raise.” “These companies were pushed to raise as much equity capital as outside experts thought they could do under the circumstances, and real, loss-absorbing equity levels were increased by other means, such as asset sales,” Walsh said. Walsh added that the regulators wanted the banks to repay as quickly as possible. Tim Massad, assistant secretary to the Treasury, said in a separate letter that the ultimate decision to let the banks repay was left to their regulators, and he echoed Walsh’s concerns with their conclusion. “Your comment seems to assume that market conditions would have allowed even larger stock offerings sooner thereafter. Moreover, postponing those offerings could have risked undermining investor confidence and the ultimate goal of restoring financial stability,” Massad said. Write to Jon Prior. Follow him on Twitter @JonAPrior.