With the latest Fed stress tests out of the way, US banks and investors are now weighing up the potential impact of the next major regulatory move – the so-called Orderly Liquidation Authority resolution rules, which could see the eight largest US banks having to issue at least US$83bn of subordinated bonds in coming years.
Banks were hopeful that the Fed would release a so-called Notice of Proposed Rulemaking as early as the second quarter, which would outline just how much debt and equity as a percentage of risk-weighted assets the eight largest US firms would need.
But now it seems it may not be until November that those eight – Citigroup, Bank of America, JP Morgan, Wells Fargo, Goldman Sachs, Morgan Stanley, State Street and Bank of New York Mellon – will get any clarification as to how much in senior unsecured and subordinated bonds they will need to keep on their balance sheets.
“It seems to have been delayed again,” said Bernard De Longevialle, lead analytical manager for S&P’s financial institutions division, who spoke after a bank conference held by S&P in New York on Thursday. “The regulators haven’t said anything, but it doesn’t look like we’ll know until late this year.”
He spoke after hearing comments from Herbert Held, the Federal Deposit Insurance Corp’s deputy director for systemic resolution planning and implementation, who indicated that US regulators would probably co-ordinate their so-called Single Point of Entry resolution mechanism with the UK Financial Stability Board’s own version.
The Single Point of Entry mechanism is a key component of the OLA resolution regime under Title II of the Dodd-Frank Act and is designed to allow regulators to close a failed bank’s holding company while transferring healthy subsidiaries into a new institution.
A comment period on those rules closed on March 20, but until the rules governing the mechanism are nailed down, it will not be decided how much debt capital US banks are required to hold – and in what form.
According to De Longevialle, the FSB is not expected to settle on a minimum debt requirement to add to the Tier 1 capital banks need to hold until the G-20 meeting in Brisbane in November.
The market is expecting that US regulators will require the US’s eight “systemically important financial institutions” to hold somewhere between 15% and 25% of Tier 1 equity and unsecured debt as a percentage of RWAs to ensure there are enough privately held securities available to absorb losses of a bankrupt holdco bank and to recapitalise a new bank housing whatever businesses are salvaged from the wreckage.
Struggling
But it’s not just the desire for co-ordination that is holding up the rules.
Steven Merriett, chief accountant of the Fed’s division of banking supervision and regulation, told the conference that regulators were struggling to come up with the right minimum debt requirement that would be enough to recapitalise a SIFI, but not so much as to overwhelm the capital markets with new debt issuance that would cause banks’ cost of capital to blow out.
“A spike in subordinated issuance could weigh on spreads, even if spread across multiple years of regulatory phase-in”
“It’s tough,” Merriett said, when asked to give some idea of when the market could expect an NPR from the Fed on the subject. “The team [working on the rules] is working really hard. The goal is to achieve some measure of debt that can be converted into equity in the new institution, but how much that should be is very difficult to measure … [They need to consider] the ability of the market to bear this issuance and what prices would be charged.”
Much more?
Barclays strategists expect the rule to require the eight US SIFIs to hold Tier 1 capital at 8.5% of risk-weighted assets and then another 8.5%–11.5% in unsecured debt, to take the total amount of debt and equity capital to between 17% and 20%.
The market consensus is that outstanding subordinated bonds will be required to equal 3% of RWAs, which Barclays estimates would require US$83bn of sub-debt issuance between now and the expected 2019 phase in deadline.
But the amount of sub-debt could end up being much more.
“[The percentage of sub debt] would actually need to be at least 5% of RWAs to be a credible means to recapitalise a SIFI without resorting to senior debt impairments,” wrote Brian Monteleone, a senior bank credit strategist at Barclays, in a research note.
Whatever the number, any requirement for extra sub debt means higher capital costs, as well as a possible widening in sub debt spreads.
“Our estimates [of an 18.5% base case total equity and debt requirement] represent a sizeable 70% increase in the balance of holdco subordinated debt outstanding across these eight firms, to US$201bn,” said Monteleone.
The eight US SIFIs currently have US$118bn of subordinated debt outstanding, so if Barclays’ base case comes true, it would require another US$83bn of sub debt to be raised across those firms to reach a 3% of sub debt to RWA level. That US$83bn of extra sub debt would represent a sizeable 70% increase in the balance of their holding company subordinated debt, to US$201bn.
“Such a spike in subordinated issuance could weigh on spreads, even if spread across multiple years of regulatory phase-in,” Monteleone told IFR.
Most of the eight US SIFIs already have enough total Tier 1 and unsecured debt to meet any requirement between 17% and 20% – the big exceptions being Wells Fargo and, to a lesser extent, State Street.
Monteleone estimates that Wells would need to raise US$18bn more debt and State Street US$3bn if the requirement was struck at 18.5%, in the middle of the 17%–20% range. As for sub debt, JP Morgan and Wells would need to issue the most if the rules end up requiring subordinated bonds to be 3% of RWAs – with JP Morgan at US$29bn and Wells at US$21bn.
“Most firms would refinance existing senior debt balances as sub debt in order to meet requirements,” said Monteleone.
