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The Federal Reserve Board on Tuesday met to vote on a final Basel III package, which represents the most significant overhaul of regulatory capital requirements for U.S. institutions.
July 2 -
As the Federal Reserve Board gets set to vote on a final package of Basel III capital rules at a meeting Tuesday, it remains unclear just how far regulators will go to placate community bankers outraged by the proposal offered last year.
July 1 -
More regional and community banks have selling noncumulative perpetual preferred stock to bolster Tier 1 capital and fund expansion.
February 20
The Federal Reserve has eliminated certain hybrid instruments from bank holding companies Tier 1 capital with its recent approval of the final
Beginning in 1996, the Fed allowed BHCs to treat certain hybrid instruments as part of Tier 1 capital and regularly published the list of eligible securities in the
In 2010, Section 171 of the DoddFrank Act, commonly known as the Collins amendment, required regulators to harmonize BHC regulatory capital with the more stringent BOC capital requirements. The Dodd-Frank Act also required that the Government Accountability Office study the possible effects of the Collins amendment. The resultant
In coordination with the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, the Fed has promulgated its final and comprehensive regulatory capital rule. Among many issues it addresses, the rule imposes strict eligibility requirements for regulatory capital instruments. The rule excludes cumulative perpetual preferred stock, in addition to trust-preferred securities, from Tier 1 capital for BHCs. The
In an earlier article we wrote in Moodys Analytics, Praveen Varma and I addressed the issue of losses experienced by holders of cumulative and non-cumulative preferred stock when issuers deferred dividends. Importantly, we looked at the ability of issuers to continue operating as going-concerns when their companies did not default on their debt at the time of dividend deferral. Dividend deferrals were not followed by debt defaults in 66 cases and they were followed by debt defaults within a five-year period in 52 cases. The five-year period is crucial because the outcome of the discretionary dividend deferral decision by distressed issuers would be clear within that period.
When issuers deferred dividends on non-cumulative preferred stock, the losses were high. This was reflected in post-deferral valuations of around 15% of face value irrespective of whether a debt default followed the dividend deferral or not.
When dividends were deferred on cumulative preferred stock, the story was quite different. In cases when the dividend deferral on a cumulative preferred stock was followed by a default, post-deferral valuations of around 25% indicated losses comparable to those experienced by holders of non-cumulative preferred stock. For the cases of interest, when the dividend deferral on a cumulative preferred stock was not followed by a default, the losses were much lower: post-deferral valuations were around 38%.
This analysis has important implications for retaining cumulative preferred stock as part of Tier 1 capital. First, preferred stock investors are knowledgeable about the survival and recovery prospects of cumulative preferred stock as shown by valuation of cumulative preferred stock following a dividend deferral. The post-deferral losses of non-cumulative preferred stock are comparable only to losses of cumulative preferred stock deferrals followed by debt defaults.
In cases, where a default did not follow dividend deferrals of cumulative preferred stock, the higher valuations revealed the preferred stock investors ability to assess the relative financial health of deferring issuers. These comparative valuations indicate the ability of cumulative preferred stock to absorb losses at times of distress. Second, the retention of cumulative preferred stock as part of Tier 1 capital does not contradict the
I believe that, while the exclusion of trust-preferred stock from Tier 1 capital is understandable, cumulative preferred stock should be part of Tier 1 capital for both BHCs and BOCs when the regulators revisit the implementation of the regulatory capital rule in the U.S.
Ozgur B. Kan is a director at Berkeley Research Group. He advises financial institutions on credit risk analytics, modeling, regulatory and compliance issues.