Banks are lining up to issue a controversial new security that is being pitched as a way to sidestep proposed "corporate welfare" reform.
Banks and insurance companies plan to issue $5 billion to $6 billion of the securities in the next two weeks, market sources said. Among the banks: KeyCorp, National City Corp., and Chase Manhattan Corp.
The new instruments are a twist on trust-preferred securities, which took off last fall as an inexpensive way to raise Tier 1 capital. Scores of banks have since issued a combined $30 billion in trust-preferreds.
But Congress is looking to eliminate certain tax breaks for corporations, including the favorable treatment of trust-preferreds. That has put pressure on issuers to come to market by June, when the congressional debate on the so-called corporate welfare reform bill is likely to begin. Any ban on trust-preferreds is expected to be retroactive to the starting date of debate in the House Ways and Means Committee and the Senate Finance Committee.
The new instruments-variously known by the acronyms RACs, ROPEs, and CAPs-are designed to enable banks to lock in their ability to issue trust- preferreds in two years.
Banks are already "filled to the gills" with inexpensive regulatory capital, but they may need less costly sources of capital in the future, said bank bond analyst Thomas Stone of Duff & Phelps Rating Co.
"The profile of a bank that wants such capital for future use is one that wants to increase its asset size significantly or is looking to make an acquisition."
But observers said the issuance of the new securities could aggravate the Treasury Department, which is behind the drive to close tax loopholes for corporations.
"If enough of these securities come out," one corporate bond analyst said, "it will be antagonistic to the Treasury," which will "find a way to try to stop this product."
Depending on which firm is underwriting, the securities are known as reset asset capital securities (RACs), remarketing preferred securities (ROPEs), or convertible auction preferred stock (CAPs).
The new issues are being placed privately in an attempt to get them to the market quickly, sources said.
Cleveland-based KeyCorp placed a $250 million issue on Friday. National City Corp., also of Cleveland, was expected to price a $500 million issue Tuesday or today. Lead managers are Credit Suisse First Boston and UBS Securities Inc, respectively.
Chase Manhattan Corp. is expected to come to market with close to $1 billion of these securities later this week, with Merrill Lynch expected to be lead underwriter. And Danske, a Danish bank, is expected to price a deal later this week as well.
The new securities are being structured in various ways to preserve the tax-exempt treatment.
For instance, KeyCorp created a trust which is issuing securities that can be converted to trust-preferred securities.
Investors noted that KeyCorp issued its securities at 35 basis points over Treasuries, which is 8 basis higher than the cost of regular senior debt.
In National City's case, securities were issued as trust-preferreds but are priced expensively, at a spread over the two-year Treasury. After two years, the securities price off the 30-year bond, one market source said.
Some capital markets experts said banks may be jumping the gun by issuing the new securities before Congress' direction is clear.
"Banks that issue these securities are going to pay a premium," noted one capital markets expert who declined to be identified. "They are making a bet that trust-preferred securities are going to go away, and they are not." These new securities are "priced too cheap for the investors."
Other investors added they were also reluctant to purchase the product because it is relatively new. "After the long weekend, the security has gotten off to a slow start. It's just too early to tell," said one investor.
