5 Banks That Might Get Burned by Reform

NEW YORK ( TheStreet) -- A controversial provision in the current version of the Senate's financial reform bill could lead to dilutive common equity raises at several large banks.

The amendment, which was introduced to the Restoring American Financial Stability Act of 2010 by Sen. Susan Collins (R-Maine) and approved on May 15, would exclude trust preferred securities, or TruPS, from bank holding companies' regulatory capital ratios. A vote on the full banking reform bill is still to come.

A bank holding company's Tier 1 capital - also known as core capital - is a conservative regulatory capital measure, which excludes non-qualifying preferred stock, unrealized gains on securities, goodwill, and other intangible items including deferred tax assets, but many TruPS are included.

Because of their seniority over other share types, TruPS are thought of as "essentially debt" by some analysts and investors. The Federal Deposit Insurance Corp. has long been against including TruPS as part of Tier 1 capital, although the Federal Reserve determined in 1996 that up to 25% of a bank holding company's Tier 1 capital could be comprised of this type of equity.

The largest U.S. bank holding companies, including Bank of America ( BAC), JPMorgan Chase ( JPM), Citigroup ( C) and Wells Fargo ( WFC) had relatively small portions of their reported Tier 1 capital in TruPS as of March 31, and the group would see little impact from the amendment.

But some holding companies that have higher portions of Tier 1 capital in TruPS look vulnerable and could need to raise additional common equity, depending on how the exclusion ends up being enacted, if it happens at all.

In a gently-worded statement, Rochdale Securities analyst Richard Bove said the provision would require that "American banks withdraw from the global financial system because Americans would not be allowed to compete." He went on to say that enacting the amendment as written would "result in the loss by America of the world's core currency and the shrinking of the American economy."

Using data supplied by SNL Financial, the following five banks had the highest levels of qualifying trust preferred securities as part of their Tier 1 capital among the largest 50 U.S. bank holding companies as of March 31. The list excludes South Financial Group ( TSFG) because it's since agreed to be acquired by TD Bank Financial Group ( TD).

The Tier 1 risk-based capital ratio needs to be at least 6% for a bank to be considered well capitalized under ordinary circumstances. Regulators are still mulling what appropriate capital levels should be for the industry, especially for holding companies that owe the government bailout money received through the Troubled Assets Relief Program, or TARP, or are facing significant loan losses.

5. M&T Bank Corp ( MTB) of Buffalo, N.Y. had $1.15 billion in qualifying trust preferred securities as of March 31, or 20% of Tier 1 capital, according to SNL Financial. The company owes $600 million in TARP money and its Tier 1 risk-based capital ratio was 8.9% as of March 31.

The company's largest shareholder is Allied Irish Banks PLC ( AIB), which recently announced plans to sell its reported 22.5% stake in M&T during 2010.

In a recent report on the effect of the possible exclusion of trust preferred securities from Tier 1 capital on large regional bank holding companies, Credit Suisse analyst Craig Siegenthaler said that since M&T's capital levels were already relatively low, "the amendment poses an additional headwind for MTB as its Tier 1 ratio will decline to 7.1% vs. the Regional Banks peer group average of 10.6%."

M&T stands out among the large banks still owing TARP money because it has remained profitable through the credit crisis and has decent loan quality. M&T's ratio of non-performing assets to total assets as of March 31 was 2.07%, which was the lowest for the five holding companies being discussed here, and compared favorably with the national aggregate nonperforming assets ratio of 3.43% reported by the FDIC.

The company's first-quarter ratio of net charge-offs (actual loan losses) to average loans was a low 0.73%, with loan loss reserves staying way ahead of the pace of loan losses, to cover 1.73% of total loans. M&T's charge-off ratio was the lowest among the group of five holding companies by far, and compared to a national aggregate of 2.84%.

The risk to M&T's shareholders is that regulators could require a raise in common equity before the company pays its off TARP tab, since a Tier 1 risk-based capital ratio of 7.1% (excluding TruPS) wouldn't greatly exceed the 6% benchmark for a well capitalized bank. Shares closed Wednesday at $79.67, up 21% year-to-date.

4. Fifth Third Bancorp ( FITB) had a Tier 1 risk-based capital ratio of 13.4% as of March 31 -- the highest among our group of five. The company had $2.8 billion worth of qualifying trust preferred securities, or 21% of its Tier 1 capital.

Excluding TruPS, Credit Suisse estimates Fifth Third's ratio would decline to 10.6%, which would still be high for a regional bank holding company in a normal credit environment.

In June 2009, after regulatory stress tests were completed, Fifth Third raised $1 billion in common equity. The company had previously raised $1.1 billion through a preferred offering in June 2008, and it still owes $3.4 billion in TARP money.

Fifth Third's first-quarter results showed the company clearly turning a corner with reduced loan losses, lower nonperforming assets, and excess capital to ride through the latter stages of the credit crisis and repay TARP. But throw in an unexpected $2.8 billion Tier 1 capital hit, and Fifth Third's common shareholders would likely be facing yet another dilutive secondary offering.

Fifth Third's shares closed at $13.05 Wednesday, up 34% this year.

3. BB&T Corp. ( BBT) had $3.5 billion in qualifying trust preferred equity as of March 31. This would come to 25.6% of Tier 1 capital, although current reporting rules require the company to limit the TruPS component of their reported Tier 1 capital to 25%.

BB&T's Tier 1 risk-based capital ratio was 11.6% as of March 31 and Credit Suisse estimates that if trust preferred securities were excluded, the ratio would drop to 8.6%, which is still a pretty high level. Also in the bank's favor is that it has already repaid TARP, so it wouldn't face extra regulatory pressure to raise capital.

The bank has remained profitable through the crisis, although earnings have been hurt by elevated loan loss provisions. While nonperforming assets continued to increase in the first quarter, the pace of increase slowed, and BB&T reported declines in early-stage loan delinquencies.

Hilliard Lyons analyst Ross Demmerle was neutral on BB&T in a report published on April 26, saying the shares were "fairly valued" at $34.28. The stock has pulled back 10% from there to close at $30.73 on Wednesday, although they were still up 22% year-to-date.

At these levels, the shares aren't especially cheap, selling for 2.1 times tangible book value and 19.7 times the current average estimate of analysts polled by Thomson Reuters for 2010 earnings of $1.50 a share. However, for investors with long term horizons, the stock is attractively priced at right around 9.6 times Wall Street's current 2012 consensus view for a profit of $3.10 a share.

2. Capital One Financial ( COF) had $3.6 billion in qualifying trust preferred securities as of March 31. The company's ratio of qualifying trust preferred securities to Tier 1 capital was a whopping 31.6%, although reporting rules require the company to limit the trust-preferred component of reported tier 1 capital to 25%.

Capital One's Tier 1 risk-based capital ratio stood at 9.6% as of March 31. Credit Suisse estimates the ratio would drop to 6.5% if trust preferred equity was completely and immediately excluded from Tier 1 capital.

A heavy-handed and quick implementation of the Collins amendment would make a dilutive secondary offering of common shares a real possibility for Capital One, but given a little time the company should be able to sufficiently boost its capital through earnings.

Capital One's first-quarter net income came in at $636 million, or a return on average assets of 1.39%, and a return on equity of 12.15%. Those excellent numbers (in the current environment) reflect the company's determination that the quality of its credit card portfolio had improved enough for it to reduce its quarterly provision for loan loss reserves to $1.47 billion, even though net loan charge-offs totaled $2 billion during the quarter. Continued "releasing" of reserves bodes well for both subsequent quarters and the Tier 1 risk-based capital ratio.

A company spokesperson told TheStreet: "it's premature to speculate on the pending legislation."

Shares closed at $41.75 Wednesday, up 9% this year, after pulling back from a high of $46.73 on April 23. At that level, the stock was trading at 1.8 times tangible book value and 11.2 times Wall Street's average 2010 earnings estimate of $3.60 a share.

1. Out of the 50 largest domestic bank holding companies, Popular, Inc. ( BPOP), of San Juan, Puerto Rico had the highest ratio of qualifying trust preferred equity to Tier 1 capital as of March 31, at 33.6%. Qualifying trust preferred equity totaled $814 million.

The company's Tier 1 risk-based capital ratio was 9.5% as of March 31, and based on a calculation that removes the allowed 25% of reported Tier 1 capital that was comprised of TruPS, the ratio would drop to 7.1%. However, that excludes the effect of the company's recent acquisition of $9.4 billion in assets from the failed Westernbank Puerto Rico, and a preferred equity raise of $1.1 billion that has already been converted to common equity and will be included as Tier 1 capital.
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Popular converted the $935 million in TARP money it owed to trust preferred securities in August 2009.

Another recent development was Popular's announcement that it's received a number of bids to sell a majority stake of its Evertec technology subsidiary. According to B. Riley & Co. analyst Joe Gladue, the sale "would permit Popular to recognize a gain of $700 to $750 million."

For Popular, the major concern is loan quality, as nonperforming assets comprised 7.43% of total assets as of March 31, although reserves appeared adequate, covering 5.51% of total loans, while the net charge-off ratio was 3.84%. Puerto Rico's unemployment rate exceeds 16% and Popular's management has said that nonperforming loans could continue to increase for several quarters, so it remains to be seen when the company will turn a corner.

Despite the bank being in flux, Gladue is bullish on the shares with a 12-month price target of $4.25. Shares closed at $2.95 Wednesday, up 31% year-to-date.

-- Written by Philip van Doorn in Jupiter, Fla.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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