KeyCorp is the first bank to come to market with a new hybrid form of capital security that could herald a cheaper way for banks to raise Tier 1 capital.
This week the Cleveland-based banking company issued $250 million of "bullet" capital securities-a form of trust-preferred securities that do not have a traditional call option - with a yield of 6.99%, or 137.5 basis points over 30-year Treasuries. The issue, marketed to institutional investors, was oversubscribed by two times.
The new security, designed by Credit Suisse First Boston, will let banks raise regulatory capital much more cheaply than they could before, investment bankers said. Since bank trust-preferreds first came to market three years ago, the Federal Reserve has only approved those with "hard" call options.
"Other companies have issued this kind of security, and I believe that the Fed finally approved this one because it did not want banks to be at a competitive disadvantage," said ratings analyst James Moss of Duff & Phelps.
Other companies that have issued these types of securities include Transamerica, Travelers, and Conseco.
Market experts said they do not expect banks to flood the market the way they did when trust-preferreds-designed by Goldman, Sachs & Co.-debuted in 1996. However, other banks will most likely follow KeyCorp's lead.
Bank-issued capital securities have kicked up much controversy because they are tax deductible and can qualify as Tier 1 capital.
In the last three years banks have issued $40 billion in capital securities.
The newer securities have a 30-year maturity like other capital securities and "make-whole" calls, meaning that the company can call the bonds at any time but must pay the investor a premium once the bonds are called.
Traditional capital securities are callable by the bank in either five years or 10 years. Issuers, however, must pay an additional spread or yield premium to investors for the call option; the traditional securities for institutional investors requires a premium call price in the 10th year.
Investment bankers say that KeyCorp saved as much as 20 to 30 basis points by issuing this type of security because it is not paying a premium up front.
This type of security appeals to a range of investors because it does not have the traditional call feature, market experts said. The market for callable debt has been sluggish, they added.
"This won't do a lot for issuance volume," said Suni Harford, managing director of capital markets at Salomon Smith Barney, which helped underwrite the KeyCorp issue. "Many banks are well or over capitalized so they do not need Tier 1 capital right now."
Banks also will be reluctant to refinance their old capital securities with these newer ones, said Gregory Williams, a managing director at Deutsche Bank.
"Banks will not be able to repurchase securities without Federal approval," he said. "And because most of the calls are for five years or 10 years, it would be an expensive, sloppy, and difficult process."