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

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

Comments

[IE]

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.

Brilliant writing.  This is why I come to this site.

[sheeple]

Too big to fail

not late to bail

asset on fire-sale

burn all the trails

none goes to jail

[jkruffin]

Stress Test part deux???  As if the first stress tests were real right? 

[Rogerwilco]

No problem, they'll just call in $100B of those pesky small business loans. Loan officers never really liked those little bastards anyway, and it's so entertaining to watch them scramble to pay their balance in 90 days!

[unwashedmass]

Susie is my Senator....and totally co-opted by the big banks. Since she's about as bright as the dimmest light bulb on a distance porch, I can assure you that she had no intention whatsoever of actually doing anything that might harm the banks......and simply did not understand the ramifications of the amendment that some thinking underling tried to send thru.

That person will be fired within hours, rest assured, and the amendment will be withdrawn.

Wait for it.

[docj]

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.

And that (plus that Collins is, nominally, a Republican) is pretty much why this doesn't have a prayer in Hell of passing, right?

[lizzy36]

BarCap with an interesting note on this issue:

According to a note by Joseph Abate of Barclays Capital on Friday, possessing TBTF status has lifted banks’ debt by three to four notches more than their balance sheets would suggest.

So losing that status could give a bank’s access to short-term money markets a bit of a nasty squeeze, as the note explains (emphasis and link FT Alphaville’s):

Money market funds currently hold $2.5trn in short-dated assets and are one of the dominant, cash long investors in the front end. More than half of these balances are held in commercial paper and repo. Most of their repo is held against liquid collateral: Treasuries, agencies, and MBS. Since 2007, all but a negligible amount of money fund CP is A1, or Tier 1 paper. Governed by newly tightened 2a7 rules, the money funds are severely limited in their ability to purchase non-A1 assets or engage non-A1 counterparties. Under these new rules, they can invest only 3% of their overall assets in Tier 2 securities, and the maturities on these holdings are limited to less than 45 days. Similarly, they face counterparty limits of just 0.05% to any one A2 issuer.

Which might pose a problem for Goldman Sachs, Citigroup, Bank of America and Morgan Stanley, which are most at risk of downgrade, according to Abate.

http://ftalphaville.ft.com/blog/2010/05/21/239976/of-reform-us-bank-ratings-and-repo/

[benevolous]

And to think, the Collins amendment was approved by unanimous consent by the world's greatest deliberative body on May 13 and it's just now being noted here.

- Collins amendment #3879 (leverage and risk-based capital) was agreed to by unanimous consent.

http://democrats.senate.gov/calendar/2010-05.html