Comerica Inc.'s redemption of $500 million in trust-preferred securities will save it more than $20 million a year and sets an example of Dodd-Frank Act adaptation for a handful of other regional banks.
But the financial reform law's restrictions on the hybrid securities affect a minority of the largest trups issuers, and not even all of these banking companies may want, or be in a position, to redeem the paper immediately.
This does not mean that redemption is not attractive. "If you're over $15 billion [in assets], your trups are not going to get Tier 1 treatment," said Brett Jefferson, the founder and chief investment officer of Hildene Capital, a hedge fund that invests in downtrodden trups. "And trups are not cheap — the early ones were issued at very high fixed rates."
Jefferson said he believes as little as 14% of outstanding trust-preferreds in the collateralized debt obligations he follows were issued by such sizable institutions, however, and not even all of those will be able to duplicate Comerica's feat of repurchasing trups without raising capital.
Trups were a point of controversy during the run-up to this summer's financial reform legislation as the Federal Deposit Insurance Corp. and others cited the hybrid debt and equity instruments' shortfall as loss-absorbing capital during the credit crisis. Even in cases where banks agreed to covenants requiring that any redeemed trups be replaced by common equity, "these securities have not proven to be loss-absorbing for a bank," said Barbara Havlicek, a senior vice president at Moody's Investors Service.
Despite skepticism about trups' value, smaller institutions won an exemption from Dodd-Frank's restrictions through an amendment added by Sen. Susan Collins, R-Maine. Those with more than $15 billion of assets, however, were barred from counting trups as regulatory capital after a three-year phaseout, beginning in 2013.
The change in legal status defeated the purpose of large institutions' outstanding trups and triggered a standard provision in trups agreements that lets an issuer repurchase the debt at face value without penalty.
As analyst Steven Alexopoulos of JPMorgan Chase & Co.'s securities unit noted the day of Comerica's Sept. 1 announcement, some large banks that had issued trups were already contemplating retiring them before the reform package passed.
TCF Financial Corp., for instance, had issued trups with a yield of 10.75%. Assuming the legislation's success, said CEO William Cooper on TCF's second-quarter earnings call, "that gives us the right to call them now. … 10.75% is pretty expensive, and we'll look at the option of refinancing that in a different way."
Alexopoulos wrote that the banks he covers "would remain well capitalized even with an immediate exclusion of trups from Tier 1 ratios," so "we could see more take advantage of saving quarterly interest expense by redeeming trups."
Complications exist, however. Some banks obliged themselves to replace redeemed trups with equity to protect more-senior creditors. Calling the trups would therefore require capital-raising, just as repaying Troubled Asset Relief Program money did.
In Comerica's case, a March common equity issuance appears to have qualified as such a sale, Alexopoulos noted. But other banks wishing to redeem might have to float new shares.
Another unresolved issue is the timing for redemption. Though it was standard for trups to have a 90-day redemption opportunity in the case of regulatory capital changes, grounds for disagreement may exist as to when that window opens. "Whether it's passage of the [Dodd-Frank] Act or when the capital treatment starts to change could be subject to interpretation," said Rita Sahu, an assistant vice president at Moody's.
All told, the redemption option is mildly positive, Moody's said, letting affected banks extinguish the high-cost securities without penalty and replace them with equity, a stronger type of capital, or with debt, which is cheaper.