Rules confusion puts US banks in debt limbo

America's largest banks face an unsettling wait for the Federal Reserve to clarify a quirk in its interpretation of new global capital requirements that could potentially disqualify billions of dollars of senior unsecured debt. Because US banks tend to issue through their holding companies, expectations had been that their senior bonds would meet the Financial Stability Board's new subordination rules and qualify as loss-absorbing.
However, a consultation paper published by the Federal Reserve at the end of October has changed those expectations. The paper addressed provisions in existing senior bonds that allow acceleration of payments for reasons other than insolvency or payment default. The paper proposed that debt with such terms would not be TLAC-eligible. The Fed wants to restrict payment acceleration for other reasons so it has free rein to impose losses on holders of TLAC-eligible long-term debt when banks fail.
Under the proposal, the amount of TLAC debt US banks need to raise jumps to US $550bn, according to research firm CreditSights. That is much higher than the Fed's own estimate of US $120bn, though that number seems not to take into account the debt that would no longer count as TLAC-eligible. Wells Fargo and BNY Mellon flagged the issue to investors in documentation for their recent three-year and five-year deals.
"Every bit of holding company debt I've looked at has those covenants and it would all have to be reissued, the way the rule proposal is written," said Oliver Ireland, a partner with Morrison Foerster. In the event that the proposal is enacted, another solution would be for banks to go through a consent exercise to convince investors to allow changes in the terms of existing bonds - but that is likely to prove expensive.
"It is a lot of paperwork and a significant undertaking, but better than having to issue extra debt," said Pri De Silva, a senior analyst at CreditSights. The largest eight US banks must meet at least one-third of their TLAC requirement with long-term debt rather than equity. That could be senior or subordinated debt, so long as it meets the Fed's criteria. The uncertainty is inconvenient for banks, said De Silva at CreditSights. Under the proposals, banks would lose 50% of TLAC treatment for senior debt maturing beyond 2020 and 100% for debt maturing beyond 2021.