While the market is digesting the new ABS proposals from the Securities and Exchange Commission, a separate batch of proposals from the Federal Reserve Board were being doled out to bank holding companies. One proposal would allow just 25% of Tier 1 capital to be comprised of trust preferred securities, for regulatory capital purposes. Last year the regulators granted temporary relief to banks that were made to deconsolidate their trust preferred securities as a result of Financial Interpretation No. 46-R.

Over the last few years, TruPS have increasingly become an attractive source of collateral for CDOs. Issuers and dealers of CDOs have been grappling with the potential changes - if there are any - which the regulation could have upon securitizations backed by TruPS.

"My biggest concern is that it could have a cooling effect on new issuances," said one CDO researcher.

Identified as R-1193, the document proposes continued inclusion of trust preferred securities (TruPS) in the Tier 1 capital of bank holding companies, but subject to "stricter quantitative limits and qualitative standards," it states.

A three-year transition period is proposed, in which the aggregate amount of TruPS (and certain other capital elements) would be limited to 25% of Tier 1 capital elements net of goodwill. A key distinction, however, is made between "internationally-active" bank holding companies, which would be expected to limit TruPS (and other capital elements) to 15% of Tier 1 capital elements, net of goodwill during the transition period.

Since then CDO pundits and the bank holding community have found themselves unlikely partners in researching effects of the proposal. Banks benefit from fresh capital infusions by issuing trust preferred securities and, since 2001, the CDO market has enjoyed pooling these securities together to create new collateral for securitization vehicles.

"It's an issuer-friendly ruling by the Fed," stressed Jim Moss, a managing director at Fitch Ratings who focuses on bank holding companies. Moss does not believe the proposal will slow down the amount of TruPS being issued by bank holding companies, which is good news for the CDO market. "Just the largest 20 banks in the country [are effected]," Moss said, pointing out TruPS in excess of Tier 1 thresholds have been counted as Tier 2 capital.

Trust preferred CDOs are typically composed of 40 to 70 small regional banks, said JPMorgan Securities' researcher head Christopher Flanagan. "The internationally active exemption means that the regulatory regime is likely to be unchanged for these issuers," he explained in a recent research piece. A typical trust preferred pool contains pooled exposure to banks with assets between $100 million and $1 billion to $2 billion. From a CDO perspective, the universe impacted by the revised small issuer rule includes only those banks with assets in the narrow slice between $100 million and $150 million, Flanagan found.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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