Wall Street Frets Fed Proposal Will Become $550 Billion Headacheby and
New debt issuance may lift bank funding costs, hurt investors
Lobbyists pushing regulators to change proposed rules
A Federal Reserve proposal to make the banking system safer may end up forcing the biggest U.S. banks, including JPMorgan Chase & Co. and Citigroup Inc. to raise as much as $550 billion more in the bond market by 2019, analysts and Wall Street lobbyists warn.
That estimate from research firm CreditSights Inc. would be equal to more than four times the amount of bonds the Fed forecasted in October that the financial companies would have to sell to meet the requirements.
The issue is shaping up to be the latest showdown between Wall Street and regulators looking to prevent a repeat of the 2008 financial crisis. Banks have had success in convincing rulemakers to loosen other proposals intended to boost bank debt relative to equity, for example.
Still, the possibility of regulators keeping the rules unchanged would be so negative that investors and banks shouldn’t ignore it now, said Rebecca Cummins, a Santa Fe, New Mexico-based money manager at Thornburg Investment Management Inc., which oversees $65 billion.
"There is a hope in the market that the language won’t be as stringent as investors think. As far we are concerned it should be wait-and-see until you see what the Fed’s game plan is," Cummins said. The Fed is seeking comment about the provision and how burdensome it would be.
The Fed rules, proposed in late October, are designed to ensure that a troubled bank will be bailed out by its stock and bondholders, ideally with no help from taxpayers.
Lobbyists say they are pressing the Federal Reserve to change a provision that worries them, and that they view the current proposal as a worst-case scenario.
If the final rule remains unchanged, banks could have to pay more to fund their operations, and the market prices of one of the best performing U.S. bond sectors in 2015 could fall in 2016.
"It is something we raise with the Fed every chance we get, because it’s such a big problem it makes people nervous," said Wayne Abernathy, a lobbyist at the American Bankers Association in Washington.
Banks, in the offering documents for bonds they are issuing, are listing the risk of the securities not being eligible to comply with the Fed’s final rule, which is expected later this year. For example, Bank of New York Mellon Corp. and Wells Fargo & Co. recently mentioned the risks in supplements to prospectuses for bond deals when selling corporate bonds.
Any earnings pressure from the rule would come at a difficult time for banks, which are expecting rising rates from the Federal Reserve to help lift revenue after years of lackluster growth. JPMorgan, due to post results on Thursday, will be the first major U.S. bank to announce fourth-quarter earnings.
Spokesmen for Citigroup and JPMorgan declined to comment. Eric Kollig, a spokesman for the Fed declined to comment.
The proposed Fed regulations are known as the Total Loss Absorbing Capacity rules or TLAC. They require, among other things, that banks’ holding companies to fund themselves with a certain amount of senior unsecured bonds relative to a measure of assets and a measure of debt.
In a time of crisis, the bonds would turn into equity, to help finance a new, healthy version of the bank.
At the time of the proposal, the Fed said in a statement that it estimated that its TLAC rules would spur banks to issue $120 billion of debt. Analysts in October and November said that banks could end up issuing less than that figure, as they reduce risky assets.
The problem for banks comes in a specific part of the proposed rule, that would prevent a large swathe of existing bonds at banks’ holding companies from counting as TLAC-eligible.
To be TLAC-eligible under the suggested regulations, the bonds need to have restrictions on when bond investors can demand immediate repayment, known as acceleration.
The biggest banks’ current contracts with investors known as "indentures," under which they issue the bonds, allow bondholders to demand the acceleration of the notes they own in multiple circumstances. These include relatively minor violations of their promises to investors known as technical defaults. In practice, investors rarely demand immediate repayment when an issuer has a technical default, but they often have the option to.
The Fed likely restricted acceleration on debt eligible for TLAC to ensure that when times are tough, the bonds can be easily converted to equity, and investors cannot instead demand early repayment, said Pri de Silva, senior banking analyst at CreditSights in New York.
Generally, the Fed is trying to exclude any debt from TLAC that may be hard to value and therefore hard to exchange into equity when a bank is in trouble, the central bank said in an article in the Federal Register in November.
The Fed may decide to grandfather in existing debt, or it may strike the proposed provision altogether, de Silva said.
If the Fed does not change its rule, banks have a number of options. They can ask investors to agree to change their bond indentures in exchange for payments. They can also issue new debt that is eligible for TLAC, in addition to the other debt they have outstanding.
The TLAC rules apply to eight globally systemically important banks, including Bank of America Corp., Bank of New York Mellon, Citigroup, Goldman Sachs Group Inc., JPMorgan Chase, Morgan Stanley, State Street Corp., and Wells Fargo.