Banks and analysts anticipate a new regulatory proposal will only have modest impact on bottom lines even though large institutions would have to sell tens of billions of dollars of additional bonds.
The rule would require banks with more than $100 billion of assets to issue long-term debt (LTD) that would be available to absorb losses in the event of failure, a standard that already applies to the eight largest and most complex banks in the US.
Twelve of the US banks that would come under the rule would have LTD shortfalls that would amount to an aggregate total of $40.99 billion, according to S&P Global Market Intelligence estimates of existing LTD and the expected requirements. Six would have surpluses totaling $20.72 billion, which puts the net shortfall across the group at $20.27 billion.
The money raised would generate interest income — the Fed pays 5.4% on balances banks park with it — and spreads on investment grade bank debt have held up relatively well after the turmoil this spring despite recent downgrades.
Assuming a cost of debt of 5.9% to 6.3%, and a yield on the money raised of 5.0%, analysts at Jefferies estimated an average drag of 2.5% on EPS across the group under a harsher interpretation of the proposal where it would have a collective shortfall of $116.1 billion.
"Our initial takeaway holds that the overall impact is very manageable," they said in a note Sept. 5. "Banks have time to comply, balance sheets will change," and the proposal might change before it is implemented.
Company guidance
Regulators have for some time described their interest in expanding LTD requirements and put out an advance notice of proposed rulemaking covering the topic late in 2022.
With the lead time, banks also now generally say the impact will be manageable.
PNC Financial Services Group Inc. Chairman, President and CEO William Demchak said Sept. 12 that his bank is about $2 billion short, but expects to close the gap at the holding company by the first quarter of next year and at the operating company about a year later. He said he broadly agrees with the proposal, citing losses to the Federal Deposit Insurance Corp.'s Deposit Insurance Fund from the failures this year.
PNC said it has been issuing debt that would be compliant under the rule since 2021, and Demchak said it would ordinarily operate with higher levels of wholesale funding than would be required by the proposal.
Fifth Third Bancorp issued $1.25 billion of senior debt in July that it believes was "the most oversubscribed single tranche issuance in regional bank history," CEO and President Timothy Spence said at an investor conference Sept. 13. He said the bank expects to issue an additional $5 billion to $6 billion of LTD over the next several years to meet regulatory requirements, and that the "use of proceeds from these issuances should mitigate most of the impact."
Citizens Financial Group Inc. forecast that it will have to add about $4.3 billion of debt to meet the requirement, lowering EPS by 1% to 2% assuming a reduction in other higher-cost funding, primarily Federal Home Loan Bank (FHLB) advances.
M&T Bank Corp. CFO Daryl Bible said his bank has brokered deposits of about $12 billion and FHLB advances of about $3 billion, and "can easily shrink" such noncore funding as it targets issuing about $7 billion of LTD. He called the impact "minimal."
"It's basically a 30- to 50-basis-point differential in spread in the borrowing costs on anywhere up to maybe $7 billion," he said. "I view that as a pretty manageable cost if it keeps our industry safe."
Dissents
Regulators estimated that the banks subject to the rule would need about $250 billion of debt to satisfy it, and are about $70 billion short, based on averages from late 2021 to late 2022.
They also calculated that the requirement could reduce the banks' net interest margin by 3 basis points under an approach that estimated the cost of filling the shortfall as the difference between yields on five-year debt and non-jumbo, three-month certificates of deposit.
The size of the requirement proposed was calibrated under a "capital refill" framework, where the LTD would be sufficient to recapitalize a bank whose equity had been wiped out during a failure. Regulators also said the LTD would help "going concern" banks by reducing incentives for uninsured deposits to run, since there would be an additional pot of money before they would face losses, and by exerting market discipline because LTD spreads reflect investors' views on the risks at individual banks.
There were reservations among some policymakers, however. Fed Governor Michelle Bowman said the proposal could be duplicative with regulators' separate Basel III endgame proposal and would further erode a regulatory framework where rules are tailored for banks' size and individual risk profiles.
FDIC Vice Chairman Travis Hill asked whether officials would in fact "be able and willing to impose losses on bondholders following a failure," citing examples including regulators' use of a "systemic risk exception" that reflected concerns about the impact of bondholder losses when Wachovia Corp. collapsed.
On the other end of the spectrum, Consumer Financial Protection Bureau Director Rohit Chopra, also an FDIC board member, pushed for a determination of whether banks smaller than $100 billion in assets should also be subject to a similar requirement, since instability at smaller banks can pose "meaningful threats of contagion."