A popular form of bank and thrift debt could soon be reined in by regulators.
Market experts say it is just a matter of time before the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. follow the lead of the Office of Thrift Supervision, which limited thrift investment in the hybrid securities to 15% of total capital.
"I would not be surprised if other regulators were considering a similar kind of limit," said Michael E. Watt, vice president of fixed-income at ABN Amro.
The OCC and the FDIC did not return phone calls.
Limits on investment in the securities would not only affect companies that buy the debt, but also crimp the market for a form of debt that banks and thrifts have turned to in droves as a cheap way to raise capital.
Banks and thrifts issue the securities to take advantage of a tax break. Those same institutions like to invest in them because they offer a much higher yield than corporate securities or Treasuries.
"The OCC is in preliminary stages of reviewing this issue, and the FDIC tends to follow the OCC," said a source familiar with the proceedings. "Regulators have seen trust-preferred securities popping up on the balance sheet and have become concerned because of the higher risks."
In early November the OTS issued "Thrift Bulletin 73," which said thrifts must limit their "aggregate investment in trust-preferred securities" to 15% of capital.
"One of the arguments against these securities is that they have long lives and the fact they have long lives might make them look unattractive for asset-liability management," said ratings analyst Thomas Stone of Duff & Phelps Credit Rating Co.
The problem with trust-preferred securities is that they have some of the same properties as equity, which is much riskier than debt, said William Magrini, senior project manager on supervision policy at the OTS.
Issuers can defer payment of the dividend for four to five years and some of the securities are perpetual, which is an equity-like property, said Mr. Magrini.
Joseph Longino, a principal with Sandler O'Neill, a firm that underwrites and markets trust-preferred securities to other institutions, said, "Of course, I don't like" the OTS' stance. But he says he doubts that similar action will be taken by bank regulators.
The OCC and the FDIC have laid out policies indicating that trust- preferred securities are permissible investments for their financial institutions, said Mr. Longino, referring to an April 4 policy letter issued by the OCC and a Dec. 1 statement from the FDIC.
"Two of the three (bank) regulators have spoken on the subject and neither has posed limitations," said Mr. Longino. "And so far, the Federal Reserve Board has not spoken on the issue to my knowledge."
But the chairmen of thrifts and small banks continue to be anxious about policy ruling.
"Trust-preferred securities offer an attractive return," said Mr. Watt of ABN Amro. "They are getting 9% yield compared to the 4.5% yield from Treasuries. That's 450 basis point spreads. Thrifts want to invest in these securities because everybody wants to enhance earnings."
This will be a blow to savings associations because these securities gives them complete protection in a rising interest rate environment, said Mr. Longino.
Many thrifts are above the 15% limit that the OTS has set and are concerned that they may have divest some of their securities, market experts said.
Mr. Magrini said that if the trust-preferred securities are investment grade-and not perpetual-thrifts probably would not have to divest their securities.
He added that the OTS is likely to relax the policy as it becomes more familiar with the securities.
"This instrument is new to thrifts," said Mr. Magrini. Over time, when we become more comfortable with the securities, we will revisit the issue."