In a move as unsurprising as her pending loss in November, Blanche Lincoln is quietly trying to carve out a loophole for her friends at Arvest Bank. According to the Wall Street Journal:
Sen. Blanche Lincoln, one of the chief architects of the financial-regulation overhaul nearing completion in Congress, is pushing for a change that would benefit a bank in her home state of Arkansas.
The bank, Arvest Bank Group Inc., of Bentonville, Ark., is predominantly owned by the Walton family, of Wal-Mart Stores Inc. fame, perhaps the most influential family in the state and one of the richest in the U.S.
Under Ms. Lincoln’s proposed change, Arvest would be excused from a provision that could require banks to raise more capital, in Arvest’s case about $115 million. Other Senate Democrats had intended only to exempt banks with less than $10 billion in capital from the provision. Ms. Lincoln wants to raise that to $15 billion, a threshold that would exempt Arvest. It is the only bank in Arkansas with between $10 billion and $15 billion of assets, though there are some in other states.
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A spokeswoman for Ms. Lincoln said she was pushing the change to make sure “no Arkansas bank—no matter its owner—is punished” by the provision.” She didn’t discuss the issue with anyone from the Walton family but did meet with Arvest officials, her office said.
“Punished?” Really? Requiring a bank with nearly $15 billion in assets to raise about $115 million in additional capital is punishment? Depending on where Arvest’s assets fall within that $10 billion to $15 billion range, $115 million represents between .08% and 1.15% of Arvest’s worth. Oh, the humanity!
And why would Arvest have to raise the additional capital, you ask?
The issue concerns dividend-paying instruments some banks issue to raise money called trust-preferred securities, a mix of debt and equity. Banks can convert them to capital for regulatory purposes.
The Senate version of the financial overhaul would bar the securities from being counted as part of banks’ capital reserve, the cushion that absorbs losses when loans go bad. So some banks may have to raise fresh funds to meet capital minimums.
Trust-preferred securities are created when a company forms a trust in which they hold 100% of the common stock. The trust subsequently issues preferred stock to investors which, because of the payment schedule and requirements of how trust-preferred securities must be subordinated, carries a much higher interest rate than typical stock investments. When the trust is formed by a holding company, such as Arvest, the securities can be counted as Tier 1 capital for regulatory purposes (as long as certain other requirements are met), though they are treated as debt for tax purposes.
Not surprisingly, trust-preferred securities played a role in the recent financial crisis.
Trust preferred securities – also known as TruPS – are not new but their use expanded dramatically before the financial crisis and their role in exacerbating the crisis has belatedly become apparent. On June 8, a Bloomberg Businessweek article by Yalman Onaran and Jody Shenn reported on the background that led to the problem these instruments have created. The critical timeframe for its initiation is a 1996 ruling by the Fed. As the regulator of bank holding companies, it ruled that debt sold by a bank holding company (BHC) to an off-balance sheet trust it created could then be sold to investors and counted as Tier 1 capital. Early on, only the largest financial institutions had access to this market for their notes which were seen as a hybrid between common stock and preferred debt. But by 2002, investment banks had bundled issues by smaller institutions into CDOs that were given AAA ratings by the agencies and the expansion began. The Philadelphia Fed reports that 1,400 U.S. lenders had issued $149 billion of trust preferred securities by the end of 2008.
TruPS were marketed as a cheap and very attractive form of capital. They were defined as debt for tax purposes even though issuers could defer interest payments on the securities for up to five years. It was assumed that they would be sold to institutional investors and that the profits from increased lending supported by additional capital would continue indefinitely. But, over time, these CDOs were also sold to banks and the cross-ownership of other banks’ capital intensified the downward spiral as the crisis mounted. Capital charges by one bank experiencing losses triggered charges by others that held its debt.
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The Bloomberg article quotes George French, deputy director for policy in the division of supervision and regulation at the FDIC as saying the use of TruPS contributes to a downward spiral. It quotes Joshua Rosner, an analyst with Graham Fisher and Company as saying that selling TruPS back to banks was a Ponzi scheme. By April of 2010, losses were mounting. About 400 banks had suspended interest payments on 17 percent of outstanding TruPS and defaults accounted for another 13 percent of outstandings. As Joseph Mason, professor of finance at Louisiana State University, told the Bloomberg reporters, the fact that self-capitalization was taking place in a portion of the banking sector meant that losses fed on each other.
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Even with the possibility of a future ban, the prospect of a delay in dealing with this problem is frightening. Those who want to continue the use of trust preferred securities as Tier 1 capital assume that bank holding companies can continue to sell them. Is it possible to believe that investment banks will be able to convince investors to buy CDOs that bundle such securities? What ratings will the agencies give them now that losses have begun to proliferate? While selling bank capital to other banks greatly facilitated the marketing of TruPS, surely no one wants to perpetuate such dangerously incestuous relationships.
The fact is that the days when trust preferred securities were a cheap way for bank holding companies to raise capital are over. Meanwhile, the downward spiral they set in motion is likely to continue. Capital will continue to leak out of the system at what could become an accelerated rate for small and medium-sized institutions. The next financial crisis may already be underway.
So, long story short, Ms. Lincoln is attempting to carve out an exception that will only apply to one bank in Arkansas so that the bank can continue counting these trust-preferred securities as Tier 1 capital, thereby keeping trust-preferred securities appealing to holding companies, despite the fact that these securities directly contributed to the very crisis that the financial reform bill now seeks to address. I understand that Ms. Lincoln wants to keep Wal-Mart happy — she has demonstrated that time and time again. But going to such counter-productive extremes to keep them happy makes her claims of being “tough” on financial reform laughable at best. I guess now that the primary is over, it’s back to business as usual for Sen. Blanche Lincoln (D–Wal-Mart).