The Federal Reserve along with the FDIC and OCC made a final rule on capital which is effective January 1, 2015 that says nearly all banks must maintain common equity of at least 4.5% of risk-based assets plus another 2.5% in a buffer against future risks. At first look when this news hit last Thursday 6-7-12, this was simply the final order that was anticipated long ago by both investors and analysts. However, press reports expressing “surprise” and “we did not expect this” by industry professionals along with complaints from small bank executives caused us to reflect more on the Fed/FDIC/OCC capital plan.
First, Tier 1 Common Equity is the new gold standard. Next, this clearly signals that trust preferred securities are a second-class form of capital for ALL financial institutions above $500 million, not just the largest banks above $10 Billion. Despite the Collins Amendment within the 2010 Dodd-Frank Act, the regulatory agencies are overriding this prior guidance and replacing it with a one-size-fits-all capital standard. As Mom once told us, life is not always fair.
We understand why community bankers feel somewhat short-changed … but is this really a body-blow to small banks? We are not surprised to see this capital rule proposed and frankly we doubt that much change occurs after the 90-day comment period that is now underway. However, it is important to recognize that out of the approximately 1,100 publicly traded Banks and Thrifts in SNL Financial’s database, over 480 stocks reported total assets above $500 million, but less than the $10 Billion cutoff within the Dodd-Frank legislation. Most of these public companies already have qualifying ratios - the average Common Equity to Risk-Weighted Assets ratio was a healthy 13.6% and only about 10% of the list currently falls below the new 7% threshold.
For those companies not meeting these capital standards, there are 2.5 years to correct the issue. Surely, this could eventually lead to more consolidation in the Banking industry—but we already knew this change was pending. The real question in our minds is whether this uniform capital approach really makes a difference. Beyond the small banks’ griping about the regulatory capital proposal, there are real changes already anticipated on how risk-weighted assets are calculated—but this was supposed to keep the largest banks behaving “in-line”.
Perhaps the real take-away should be that trust preferred is no longer a viable form of capital (as a practical matter) and that Banks are better off repaying these issues (at par) sooner-rather-than-later as they stick with only Common Equity. This could be a terrific environment for any large bank TRUPs still trading below par. We noticed large banks C-Citigroup Inc. and STI-SunTrust Banks redeeming TRUPs late last week, even though the interest rate was not cost prohibitive. In our minds, this is a clear signal of future activity by the largest banks to remove these subordinated debentures from their balance sheets—a phenomenon that should occur at institutions beyond $10 Billion.