JPMorgan Leads U.S. Bonanza in Basel III Compliant Sales

Banks are issuing lower-ranked bonds and preferred securities in the U.S. at the fastest pace since the financial crisis, capitalizing on yield-starved investors to satisfy regulatory requirements.

Financial institutions including JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC) are meeting demands to raise more capital by selling $31.8 billion of subordinated debt and preferred shares this year, with $22.7 billion in March and April alone, according to data compiled by Bloomberg. The pace of issuance is the fastest since 2008.

Lenders need to sell the notes in part because new regulations designed to make banks safer have rendered a previously popular form -- called trust-preferred securities -- useless for capital purposes, ruling it must be replaced by 2016. Now that banks’ creditworthiness has improved, investors are snapping up the offerings because they can pay more than one percentage point of extra interest over senior bonds that rank higher for repayment in a bankruptcy.

“From an investor perspective, it is incremental yield in a historically low-rate environment,” Pri de Silva, an analyst at New York-based CreditSights Inc., said in a May 6 telephone interview. “The credit profiles of banks are a lot better now than they were in the pre-crisis days.”

Losing Funding

Wells Fargo in April sold $2 billion of 5.9 percent perpetual securities after initially marketing the debt with a higher coupon of as much as 6.125 percent, Bloomberg data show. The notes offered interest payments of more than two percentage points above the 3 percent senior notes due in 2021 that the San Francisco-based bank sold in January.

Subordinated debt and preferred shares are replacing trust-preferred securities, known as TruPS, which were popular before the crisis in part because interest payments were tax-deductible. About $149 billion were outstanding at the end of 2008, according to Federal Reserve Bank of Philadelphia data.

Banks could also count TruPS as Tier 1 capital because they allowed issuers to stop paying interest and were supposed to act as a buffer against potential losses. Lenders proved reluctant to suspend payments during the crisis because those that did risked losing other funding on concerns about their solvency.

New Regulations

U.S. regulators, implementing the international Basel III accord and U.S. Dodd-Frank Act, have ruled that banks with assets of more than $15 billion can’t count TruPS as Tier 1 capital anymore. They have until 2016 to replace the securities, and common equity and preferred shares are the main types that count as Tier 1 capital. Subordinated debt counts as Tier 2 capital, which banks are also required to maintain.

Attention in Europe has focused on additional Tier 1 notes, a similar-level as preferred shares in the U.S., where issuance has soared this year to $25.7 billion, Bloomberg data show. A total of $36.5 billion of the debt is outstanding.

“Under the new rules, there is a space in the capital structure that could be filled with subordinated debt, common equity or preferred equity,” de Silva said. The latter two “are generally more expensive, so in order to meet that capital need cost-effectively, they have been issuing subordinated debt.”

Bank Safety

The issuance comes as confidence in bank creditworthiness improves. The average cost to protect against defaults by the six-largest U.S. banks fell this week to the lowest level since the end of 2007, according to credit-default swaps prices compiled by Bloomberg. The contracts, a gauge of the banks’ risk, are used to hedge against losses or to speculate on the ability of companies to meet their obligations.

“Without question, the banks are more stable,” said Arthur Tetyevsky, a credit strategist at Imperial Capital LLC. “Even under the most extreme economic scenarios, banks should have enough capital to withstand a shock, so investors are more comfortable.”

While subordinated debtholders may not be bailed out in another crisis, “people are not particularly worried about that right now,” said Kathleen Shanley, a New York-based analyst at Gimme Credit LLC.

Emboldened by improving bank creditworthiness, investors are eager to buy their higher-yielding debt after more than five years of near-zero interest rates from the Fed.

JPMorgan is this year’s biggest bank issuer of the securities, selling $3.9 billion, according to Bloomberg data. The New York-based lender sold $1 billion of perpetual securities on March 5 that pay interest of 6.125 percent for a decade and then switch to a floating-rate coupon. The notes were initially marketed with a coupon of as much as 6.25 percent, according to Bloomberg data.

They climbed about 0.1 cent to 101.3 cents on the dollar at 9:18 a.m. in New York, rising for the sixth consecutive day, Bloomberg data show.

“The way the credit markets have been running, almost everything that comes is well oversubscribed,” said Thomas Urano, a money manager at Austin, Texas-based Sage Advisory Services Ltd., which oversees about $10 billion. “The trends have been favorable for banks to be able to place it.”

To contact the reporter on this story: Caroline Chen in New York at cchen509@bloomberg.net

To contact the editors responsible for this story: Shannon D. Harrington at sharrington6@bloomberg.net Caroline Salas Gage

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