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Thursday, March 28, 2024

Collins Amendment Will Eliminate $108 Billion From Bank HoldCo Regulatory Capital, Will Reduce Big Four Tier 1 Capital By 13%

Courtesy of Tyler Durden

With hundreds of amendments crammed into the Senate version of Financial Reform, the dust is only now settling on what the impact of all these will be for Wall Street firms. One of the less discussed amendments is that of Maine Senator Collins, which would result in the disqualification of Trust Preferred Securities from Tier 1 regulatory capital, and which if passed into law, will trim about $108 billion from bank holdco Tier 1 capital, an amount which is about 13% of the “Big 4” banks’ total Tier 1 capital according to Moody’s. The resulting need to shore up bank holdco balance sheets would be substantial and would require additional equity infusions and/or debt dispositions, as well as more FASB suspensions of various Mark-To-Market rules. Additionally, the enactment of this amendment would likely result in future downgrades of holdcos by discredited rating agencies such as Moody’s.

Here is Moody’s itself discusses this potential hit to Tier 1 capital in detail:

Trust preferreds are hybrid securities that combine the features of both debt and equity. A trust typically owned by the bank or bank holding company (bank holdco) issues preferred securities, the proceeds of which are on-lent to the bank or bank holdco through subordinated or junior subordinated debt. The securities allow the bank or bank holdco to defer coupon payments on a cumulative basis.



The Collins Amendment does not specifically disqualify trust preferreds. Instead, it imposes the same capital requirements on bank holdcos as those imposed on banks. Today, trust preferreds issued by banks do not qualify for Tier 1 regulatory capital treatment because they allow for cumulative rather than non-cumulative coupon suspension. This treatment would be extended to trust preferreds issued by bank holdcos under the amendment.



The disqualification of trust preferreds from Tier 1 capital is consistent with the approach taken on capital in the Basel Committee’s consultative paper called “Strengthening the Resilience of the Banking Sector and International Framework for Liquidity Risk Measurement, Standards and Monitoring” published December 2009. The paper states that the predominant form of Tier 1 capital should be common stock. This means that the use of certain European bank hybrids including junior subordinated debt with cumulative coupon deferral, which is similar to U.S. trust preferreds, would be restricted. Taking this position seems intuitively correct because these types of securities have generally not proven to be loss absorbing during the financial crisis despite the coupon payment flexibility that they offer.



The credit implications of the Collins Amendment are negative for most, if not all, bank holdcos that have issued trust preferreds including the “big four.” The exhibit below presents Moody’s estimate of the percentage of trust preferreds relative to Tier 1 capital that would be disqualified for regulatory capital purposes:

We expect that all rated bank holdcos would still have sufficient Tier 1 capital after excluding trust preferreds to meet all current regulatory capital requirements and remain well-capitalized. Nonetheless, the exclusion of trust preferreds would clearly erode bank holdcos’ regulatory capital cushions, although the timing for the phase-out of trust preferreds has not been specified and a transition period may be permitted.

h/t Nolsgrad

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