(This article first appeared in the Oct 17 edition of the International Financing Review, a Thomson Reuters publication)
By Danielle Robinson
NEW YORK, Oct 20 (IFR) - The biggest banks in the US might have to issue at least US$260bn of senior unsecured debt over and above what they need to run their businesses in coming years, to comply with anticipated stricter loss-absorbing capital rules and extra equity buffers to be announced by the Federal Reserve after November.
The estimate, from one of the US’s biggest banks, is a conservative one that is based on the maximum 20% level of total loss-absorbing capital to risk-weighted assets that the Financial Stability Board is expected to propose at the G-20 summit in November, in addition to a raft of additional equity buffers.
The FSB’s proposals, outlining the amount, type and location of loss absorbing capacity for global systemically important banks (G-SIBs) will be reviewed and subject to change before being finalized in 2015.
Fed governor Daniel Tarullo has hinted that the Fed’s version of the FSB rules, expected to be released at the end of this year or early 2015, might be tougher.
Some bankers also believe that once the new measures have been implemented by US G-SIBs, the Fed will also impose loss-absorbing rules on regional banks that currently undergo stress tests.
The market’s bet is that the Fed may require loss-absorbing capital, which includes equity and debt, to be somewhere between 20% and 25% of RWA at the holding company level.
According to one major bank’s estimates, the potential total shortfall of loss-absorbing capital may be close to US$400bn, if the top seven regionals and the US SIFIs have to satisfy a 20% target, in addition to the biggest banks complying with a capital conservation buffer of 2.5% and a SIFI surcharge of 1.0%-2.5%, both of which must be satisfied with common equity.
While the banks are likely to have until 2019 to comply with the rules, the extra debt issuance is significant when combined with the additional competition for dollars coming from European banks.
“The US banks are facing pretty daunting numbers from a debt issuance perspective,” said one financial institutions group expert at a US bank.
The US banks could issue equity to meet the shortfall, but they are expected mostly to focus on issuing more senior unsecured debt.
“Some of the banks are looking at a 25%-50% increase in their yearly funding requirements, and that will certainly put spreads under pressure and impact net interest margins,” said one senior FIG banker.
Wells Fargo and JP Morgan will be the hardest hit, according to analysts, followed by Citigroup and Bank of America.
CreditSights believes Wells could be on the hook for anything from US$25bn to US$85bn of additional capital needs, depending on the TLAC target stipulated by the Fed.
“We believe that minimum equity and debt requirements for TLAC has the potential to become Wells Fargo’s biggest constraint in the near to intermediate term,” CreditSights’ FIG strategists wrote last week.
“It could become a major constraint for the company, its net interest margin and credit spreads, particularly if regulators impose a higher requirement.”
Spreads could be further affected if S&P, as widely expected, puts the G-SIBs on CreditWatch negative after the Fed releases its notice of proposed rule-making on TLAC.
“The consequences are most acute for Bank of America, Citigroup, Goldman Sachs and Morgan Stanley, which could all move from the Single A category to the Triple B category,” said Barclays credit strategists in a recent report.
That could further impact spreads, because insurance companies buying fixed income bank securities would need to set aside more reserves against Triple B rated bonds than Single A rated securities.
According to the bank’s estimates, the potential shortfall for an individual US SIFI ranges widely from US$35bn to as high as US$85bn, depending on the institution’s size and the debt already on its balance sheet.
Morgan Stanley and Goldman Sachs are considered the least affected.
Some analysts believe the biggest banks will begin to start issuing extra debt immediately.
JP Morgan strategist Eric Beinstein, for instance, cites TLAC requirements along with M&A funding as one of the main reasons to expect heavier new-issue supply in coming months.
“We may see increased issuance of US banks as they move to comply with required levels of total loss-absorbing capital,” wrote Beinstein. “We are now calling for a TLAC requirement somewhere in the 20%-25% of RWA range, compared to 17%-22% before.”
Banks are expecting the FSB’s proposed rules to include a stipulation that at least 33% of TLAC minimum needs to be liabilities.
Senior unsecured debt issuance is the most likely choice for banks needing to comply with TLAC rules. The prevailing view is that subordinated debt will not be required by the Fed to be part of the mix, nor CoCos as with European banks.
That is because under the single point of entry resolution rules the US is adopting, it will be at the resolution authority’s discretion what debt it keeps for the recapitalised bank’s balance sheet, what it writes off and what it writes back up into equity in the new bank.
The regulators are expected to follow the hierarchy of the existing holding company’s capital structure when it comes to loss absorption. (Reporting by Danielle Robinson; Editing by Philip Wright)