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Capital Rule Changes Will Affect Some Regional Banks

The combination of TARP and TruPS will cause problems for a few banks.

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As a part of the Dodd-Frank Financial Reform and Consumer Protection Act, banks are losing the ability to issue trust preferred securities (TruPS) that qualify as Tier 1 capital for regulatory purposes. The "Collins Amendment" responsible for the change applies only to banks with more than $15 billion in assets and does not begin to phase in until 2013. In our opinion, this change is likely to hit the worst-off large regional banks the hardest.

TruPS are a hybrid form of capital. For regulatory purposes, most TruPS currently qualify as Tier 1 capital. For tax purposes, TruPS are currently treated like debt, allowing a tax deduction for the interest payments. When the rules first changed in 1996 to give the securities Tier 1 status, banks seized the opportunity and issued the long-dated securities. As debt, TruPS are rather expensive, but they are a relatively inexpensive form of regulatory capital. However, once the new rules are in place, TruPS will not qualify as regulatory capital and instead will simply be expensive debt. Consequently, the Collins Amendment will likely spur the banks to call their TruPS and replace them with common or preferred equity, a more expensive form of regulatory funding.

Jaime Peters does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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