Financial reform bill may spur capital raising

U.S. banks, which scrambled to raise billions of dollars in capital last year in the aftermath of the financial crisis, may not be done yet.

Tougher capital requirements are a major piece of the sweeping U.S. financial reform that passed on Thursday, but have been virtually ignored as debate has focused on provisions like curbs on proprietary trading and a consumer protection bureau.

The good news for the industry is that unlike with last year's stress tests administered by the U.S. Treasury, banks will likely have multiple years to raise funds. But banks issuing new shares could be one more factor that weighs on the stock performance of the sector, analysts said.

"The recovery for bank stocks is not going to be a straight line up," said Henry Asher, president of asset manager the Northstar Group in New York.

Banks and brokerages globally have already raised significant amounts of capital since the crisis began -- more than $640 billion, according to Thomson Reuters data, equal to about a third of all equity raised for every sector. Normally, financial companies account for about 15 percent of issuance.

Multiple provisions of the U.S. financial reform bill passed Thursday will likely force banks to raise capital.

The bill requires regulators to boost capital requirements for the biggest banks. International regulators are expected to do the same for global banks under a forthcoming set of rules called the Basel III requirements.

A separate provision of the U.S. financial reform bill, called the Collins Amendment, says banks with more than $500 million of assets will no longer be able to count instruments called trust preferred securities as capital for regulatory purposes.

That provision would affect about $120 billion of outstanding securities, according to the American Bankers Association. Banks historically issued trust preferreds because the interest on them is tax deductible, much like regular debt, but for regulatory purposes, they boost equity.

Banks with at least $15 billion in assets will no longer be able to count trust preferred as Tier 1 capital by January 1, 2016.

Banks with $500 million to $15 billion of assets will be able to keep their trust preferreds outstanding, but will have to replace them with common stock as they mature.

The banks likely to be most affected by the trust preferreds provisions including BB&T Corp and Fifth Third Bancorp, according to a report last month from Morgan Keegan & Co.


Another provision of the bill says that banks with more than $50 billion of assets cannot have credit exposure to any one institution greater than 25 percent of their regulatory, or Tier 1, capital.

"Credit exposure" is defined broadly to include things like counterparty exposure in derivatives, and exposure may be defined as the notional size of the trade, said Greg Lyons, a partner at law firm Debevoise & Plimpton in New York.

"It all has to be fleshed out in the regulations, but there could be some real capital needs that result," Lyons said.

Banks with big derivatives exposure could be most hit by the 25 percent exposure limit. JPMorgan Chase & Co, for example, has nearly $110 billion of tier 1 capital, meaning it could not have exposure of more than about $27.5 billion to any single party.

Because JPMorgan routinely makes large loans, and trades big derivative positions, that could be a significant constraint, and could spur some banks to raise more capital, or reduce their exposures. On a conference call on Thursday, JPMorgan Chief Executive Jamie Dimon said the bank is still evaluating how financial reform will affect it.

There are offsetting factors that will limit the amount of capital banks could have to raise. Many banks are overcapitalized right now by historical standards, assuming they have properly marked their books. And banks will likely earn profit in the coming years that could further reduce their need to raise capital.

But if the economy heads back into a recession, as some investors fear, the Dodd-Frank bill could push banks to raise capital during a tempestuous period.

"It may not be a good time to press banks to raise capital, but if not now, when?" Northstar's Asher said.

[Source: By Dan Wilchins, Reuters, 16Jul10]

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