Tuesday, June 26, 2012

The Fed is putting an end to the TruPS market

Trust preferred securities (TruPS) used to be quite popular among banks as a form of funding. These high dividend securities were effectively junior debt instruments (getting interest treatment for tax purposes) but got equity-like treatment for capital purposes (Tier 1 capital). Many used to trade at a deep discount because of bank risk (government bailout would subordinate TruPS) and guys like David Tepper made a great deal of money buying these in 2009. Before the financial crisis, investors even used to securitize TruPS in a CDO. But under the new regulatory regime (Fed's interpretation of Basel III) that's changing.
Knight Capital Group: - Several banks have decided to redeem their trust preferred securities following the Fed’s June 7 meeting that proposed a phase out of the Tier 1 capital treatment of the securities. Banks have 90 days from the June 7 meeting to redeem the securities under the “capital treatment event” clause.
The TruPS market is now rapidly shrinking as banks refinance these securities, replacing them with regular equity and debt.
Reuters: - Citigroup, JP Morgan and SunTrust Bank are planning to redeem more than $15 billion of trust preferred securities next month, following the US Federal Reserve's release of new capital rules last week.
BAC, TCB, BBT, WBS, KEY are some of the other banks redeeming. This was a fairly unique asset class and it's not clear where this capital will end up moving. For example, PFF, the preferred securities ETF ($9bn market value) was loaded with these. As TruPS pay down, the ETF will be forced to move capital into far lower yielding or riskier securities.

ht @RennieScinto

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