U.S. News

US Banks Get Securities Buy-Back Window

Francesco Guerrera and Justin Baer, Financial Times

The Dodd-Frank financial reform bill has opened a 90-day window for banks to buy back $118 billion in high-cost securities, a move that would enable them to replace the instruments with cheaper capital but is likely to cause tensions with regulators and investors.

New York Stock Exchange (NYSE)
Oliver P. Quilla for CNBC.com

Wall Street executives and lawyers say several banks are considering redeeming “trust preferred securities” (Trups) – a hybrid of debt and equity – by taking advantage of a clause triggered by the new rules.

Trups – equity instruments that pay interest like bonds – became popular in the financial crisis when banks sold more than $40 billion-worth to investors ranging from Warren Buffett to small savers. Financial groups are interested in buying back the securities because Trups are an expensive form of capital. Banks needed to offer high interest rates to entice investors.

Banks have an extra incentive to redeem Trups because the new law states that they will no longer count as tier one capital – a key gauge of financial strength – from 2013.

The banks can buy back the securities now because most Trups’ contracts state that a legal change gives issuers three months to redeem them at face value. The removal of Trups from tier one capital amounts to such an event, lawyers say.

“It is a big issue,” said a top US lawyer. “The question for banks is: do you want to keep paying high interest rates knowing that Trups are going to lose their status as tier one?”

However, some executives counter that redeeming Trups could upset regulators, who are against reductions in bank capital, and investors, who bought them to hold for the long term.

“Banks may find it desirable to redeem Trups but they have to think about what they are going to say to investors next time they want to raise capital,” said Chip MacDonald at law firm Jones Day.

The dilemma over Trups is emblematic of the regulatory morass faced by banks trying to navigate the effects of the new US law as well as ongoing uncertainty over new international capital standards.

Moody’s estimates that US banks have about $118 billion of Trups outstanding. The securities account for a significant part of tier one capital at lenders like Bank of America , JPMorgan Chase , Morgan Stanley and Citigroup , according to the credit rating agency.

- Additional reporting by Nicole Bullock in New York