Why Don't All Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust-Preferred ...

39 Pages·2016·1.03 MB·English

RFS Advance Access published March 18, 2016
Why Don’t All Banks Practice Regulatory
Arbitrage? Evidence from Usage of
Trust-Preferred Securities
NicoleM.Boyson
D’Amore-McKimSchoolofBusiness,NortheasternUniversity
RüdigerFahlenbrach
EcolePolytechniqueFédéraledeLausanneandSwissFinanceInstitute
D
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w
RenéM.Stulz n
lo
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OhioStateUniversity,NBER,ECGI,andWhartonFinancialInstitutions d
e
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Center fro
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whileothersdonot.Wefindsupportforthishypothesisusingtrust-preferredsecurities .ox
issuance,aformofregulatoryarbitrageavailabletoalmostallU.S.banksfrom1996to ford
Dodd-Frank.Wealsofindsupportforpredictionsthatconstrainedbanksareriskier,perform jo
u
worseduringthecrisis,andusemultipleformsofregulatoryarbitrage.Weshowthatneither rn
a
too-big-to-failincentivesnormisalignedmanagerialincentivesarefirst-orderdeterminants ls
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ofthistypeofregulatoryarbitrage. (JELG01,G21,G28) rg
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ReceivedNovember27,2014;acceptedDecember17,2015byEditorPhilipStrahan. h
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ta
te
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Acharya and Richardson (2009) argue that the use of regulatory arbitrage by n
iv
banks to “get[ting] around the capital requirements imposed by regulators” e
rs
is what made the subprime crisis a financial crisis. Since the crisis, both ity
o
n
A
p
Wegratefullyacknowledgehelpfulcommentsandsuggestionsfromtwoanonymousreferees,NorahBarger, ril 2
ALenudzr,eaYaBnelLtriaut,tAi,kFsaebliMojBørsa,gSgtieovne,nWOonlgfgeannag,SBaüschhlear,SEtenfgfeenlb,ePrhtiDlSotcrkanhearn,(PthaueleIdrivtoinre),,EJalunvKornahTnheand,dCenh,riJsotisaenf 1, 20
Zechner,andseminarandconferenceparticipantsatBankforInternationalSettlements,BentleyUniversity, 16
BristolUniversity,EuropeanSchoolofManagementandTechnology,theFederalReserveBoard,theFrankfurt
SchoolofFinanceandManagement,GoetheUniversitätFrankfurt,HECParis,NHHBergen,Oxford,Universität
Mannheim,UniversitätSt.Gallen,theUniversityofMassachusettsatAmherst,WirtschaftsuniversitätWien,
BocconiCarefinConference,theAmericanEconomicAssociation,theEuropeanFinanceAssociation,andthe
NapaConferenceonFinancialMarketsResearchforhelpfulcommentsandsuggestions.Wearegratefulforthe
valuableresearchassistanceprovidedbyBrianBaugh,AndreiGonçalves,andRileyHeiman.Fahlenbrachthanks
theSwissFinanceInstituteforgenerousfinancialsupport.Stulzservesontheboardofabankthatisaffectedby
capitalrequirementsandconsultsandprovidesexperttestimonyforfinancialinstitutions.Sendcorrespondence
toRenéM.Stulz,TheOhioStateUniversity,FisherCollegeofBusiness,806FisherHall,2100NeilAvenue,
Columbus,OH43210-1399;telephone[phone].E-mail:[email protected].
©TheAuthor2016.PublishedbyOxfordUniversityPressonbehalfofTheSocietyforFinancialStudies.
Allrightsreserved.ForPermissions,pleasee-mail:[email protected].
doi:10.1093/rfs/hhw007
[10:2511/3/2016RFS-hhw007.tex] Page:1 1–39
TheReviewofFinancialStudies/v0n02016
economists and regulators have paid considerable attention to regulatory
arbitrage. Concerns about regulatory arbitrage have played a central role in
thedesignofBaselIII,sinceregulatorsbelievethatthenewBaselIIIleverage
ratioismuchmoreresistanttoregulatoryarbitragethancapitalrequirements
using risk weights. While the literature has shown that certain banks used
regulatoryarbitragetoincreaserisk—forinstance,byputtingassetsoff-balance
sheet (Acharya, Schnabl, and Suarez 2013)—it has not addressed why some
banksengageinregulatoryarbitrageandothersdonot.Addressingthisissueis
importantinunderstandingbankbehavior,aswellasitsrelationshiptothecrisis.
Withoutknowingwhysomebankschoosetoengageinregulatoryarbitrage,it
isdifficulttopredictwhichbankswilluseregulatoryarbitragetotakeonmore
riskandwhentheywilldoso.Inthispaper,wedevelophypothesesregarding D
o
w
the determinants of the use of regulatory arbitrage and test these hypotheses n
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usingbanks’issuanceoftrust-preferredsecurities(TruPS)—ahybridsecurity ad
e
uhsoelddiansgacroemguplaantoiersyianrbthiteraUgneivteedhiSctlaet—eswfrhoimch1w9e9r6eatova2i0la1b0l.etoalmostallbank d from
There is a general belief that a major determinant of regulatory arbitrage http
i(se.gth.,eAinchceanrytiaveasndofRliacrhgaerdbsaonnk2s0t0o9;exCpalrobitó-tVooal-vbeigrd-teo,-Kfaailne(T, aBnTdFR)osdurbisgiudeiezs- ://rfs.o
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Fernandez2013).TherelationbetweenTBTFstatusandregulatoryarbitrage fo
cannotbeinvestigatedwithformsofregulatoryarbitrage,suchasasset-backed rdjo
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commercialpaper(ABCP)conduits,thatareonlyavailabletoTBTFbanks.By rn
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contrast, we can investigate whether regulatory arbitrage is driven by TBTF ls.o
status,sinceTruPSwereavailabletoalmostallbankholdingcompanies.We rg
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find strong evidence that TBTF status is not the main driver of regulatory t O
arbitrage withTruPS.The determinants ofTruPS usage are unchanged if we hio
exclude banks with more than $50 billion of assets (potential TBTF banks) Sta
from our sample. Similarly, some argue that regulatory arbitrage is driven te U
by misaligned managerial incentives that led banks to take on excessive risk niv
e
(BebchukandSpamann2010;AcharyaandRichardson2009).Thewidespread rs
availabilityofTruPSenablesustoinvestigatetheexcessrisk-takinghypothesis ity o
n
inasamplewithsignificantvariationinmanagerialownership.Wefindthatthe A
p
useofTruPSincreaseswithmanagerialownership.Ourfindingisnotconsistent ril 2
withargumentsthatregulatoryarbitrageresultsfromexcessiverisktakingby 1
, 2
managers with misaligned incentives—we would expect banks with higher 0
1
6
managerialownershiptohavebetteralignedincentivesthanbankswithlower
managerialownership.
Our hypothesis to explain the variation in usage of regulatory arbitrage is
thatbankshaveoptimallydifferentlevelsofrisk.Theoptimalrisklevelistied
to the bank’s franchise value or business model. Some banks have business
modelsthataremoretransactionalandhavelowfranchisevalue.Thesebanks
seekahigherlevelofrisktomaximizeshareholderwealth,butareconstrained
indoingsobycapitalrequirements(constrainedbanks).Regulatoryarbitrage
enables constrained banks to take more risk. By contrast, banks with high
2
[10:2511/3/2016RFS-hhw007.tex] Page:2 1–39
WhyDon’tAllBanksPracticeRegulatoryArbitrage
$30
$20
$10
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-$20
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-$40 fro
Common stock Perpetual preferred stock Trust-preferred securities m
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FNiegtuirsesu1anceofcommonstock,perpetualpreferredstock,andtrust-preferredsecurities ://rfs
Thefigureshowsthenetissuanceofcommonstock,perpetualpreferredstock,andtrust-preferredsecuritiesby .ox
samplebanksbetween1996and2007.They-axisshowsthenetissuanceamountsinbillionsofU.S.dollars. fo
ThefigureisconstructedfromdataprovidedbySnLFinancial. rd
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franchise value (unconstrained banks) want to preserve that value and do .o
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not benefit from regulatory arbitrage and hence are not expected to use the a/
regulatoryarbitrageopportunitiesavailabletothem.Wefindstrongsupportfor t O
h
thishypothesis. io
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Banksacrosstheglobewidelyusedvarioustypesofhybridcapitalforthe ta
te
purpose of regulatory arbitrage before the crisis. In the United States,TruPS U
n
werethemainformofhybridcapitalthatbankscoulduse.InOctober1996,the iv
e
Federal Reserve Board authorized bank holding companies to includeTruPS rsity
as Tier 1 regulatory capital up to a threshold level. As shown in Figure 1, o
n
from1996to2007,U.S.bankholdingcompaniesintheaggregaterepurchased A
p
commonstockandissuedTruPS.TruPSarecumulativenonperpetualpreferred ril 2
securitiesissuedbysubsidiariesofbankholdingcompanieswhosesoleasset 1, 2
is junior subordinated debt issued by the bank holding company. As with 01
6
other debt, interest onTruPS is tax deductible to the bank holding company.
InterestpaidtothetrustonthedebtisusedtopayquarterlydividendstoTruPS
investors. Interest payments are deferrable for up to twenty quarters without
triggering default. Postcrisis regulatory changes eliminated this regulatory
arbitrageopportunity.
AnunconstrainedbankhasnoreasontoissueTruPS.Ifitwantstobecome
riskierthroughanincreaseinleverage,itcandosowithoutusingTruPS.The
taxadvantageofTruPSrelativetoequityisnotvaluabletosuchabankbecause
itcouldreplaceequitybydebttogainthesameadvantage.Aconstrainedbank
3
[10:2511/3/2016RFS-hhw007.tex] Page:3 1–39
TheReviewofFinancialStudies/v0n02016
isonethatwouldprefertoberiskierthancapitalrequirementsallow.Because
TruPSarepartdebtandpartequity,substitutingTruPSforequityamountsto
increasingthebank’sleveragewithoutchangingitsTier1capitalratio.Hence,
a bank that is otherwise constrained by capital requirements can effectively
increaseitsleverageusingTruPS.Wethereforepredictthatconstrainedbanks
will issue TruPS because it allows them to be riskier, while still satisfying
capitalrequirements.
Totestourhypotheses,wemustdeterminewhetherabankisconstrainedby
capital requirements. We use two proxies for whether a bank is constrained.
The first proxy is a bank’s franchise value. An important finding in the
bankingliteratureisthatbankswithhigherfranchisevalueholdmorecapital
because these banks have more to lose if they fail (see, for instance, Marcus D
o
w
1983; Marcus 1984; Keeley 1990; Demsetz, Saidenberg, and Strahan 1996). n
lo
High franchise value could arise from a number of factors, such as valuable ad
e
rferalantcihoinssehivpasl,uaesprtoofibtaeblleesdsecpoonsisttrbaainsee,danbdyscoapointa.lWreeqeuxipreemctebnatsnkasnwdittohhhioglhd d from
littleornoTruPS.Wefindstrongsupportforthisprediction.Oursecondproxy http
iaswaomrldeaisnurwehoifchhorawisicnlgosceaapitbaalnqkuiicsktloyiitsscroesgtulyla,tboarynkcsapwiitlallhthorldeshaobldu.ffIenr ://rfs.o
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stock of capital to cope with adverse shocks and to avoid the cost of having fo
toraisecapitalunexpectedly.Weconsiderabankasconstrainedbyregulation rdjo
u
if its buffer stock of capital is low.1 Using the second proxy, we also find rn
a
evidenceconsistentwithourhypotheses.BanksaremorelikelytouseTruPS ls.o
if they are more constrained, that is, if their excess regulatory capital levels rg
a/
arelow. t O
Alternative reasons can be advanced for the issuance of TruPS by banks hio
that are unrelated to regulatory arbitrage. In particular, as a hybrid capital Sta
instrument, TruPS could allow the issuing bank holding company to avoid te U
inefficient liquidations or help resolve debt-equity conflicts. Further, TruPS niv
e
interest is tax deductible. However, bank holding companies could have rs
obtainedthesamebenefitsbydirectlyissuingdeeplysubordinateddebtprior ity o
n
to and after 1996. Such subordinated debt issues would have been nearly A
p
economicallyequivalenttotheTruPSstructureofissuingdeeplysubordinated ril 2
debttoasubsidiarytrustwhichthenissuesTruPS.Yetwefindthatover85% 1
, 2
ofbankholdingcompaniesinoursampleneverissuesubordinateddebtunless 0
1
6
it is related to TruPS issuance, and we view this as evidence in favor of the
regulatoryarbitragemotive.
1 We recognize that this approach is somewhat imprecise for two reasons. First, there are multiple capital
requirements,sothatabank’sbufferstockmightdiffersubstantiallyacrossmeasures.Forinstance,U.S.banks
mustmeetaregulatoryleverageratiotestinwhichthedenominatorofthecapitalrequirementformulaistotal
assetsratherthanrisk-weightedassets.Abankcanhavealargebufferwithrespecttotheratiothatusesrisk-
weightedassetsbutalowbufferwithrespecttotheleverageratio.Second,abankcouldchoosetohavealower
bufferstocksimplybecauseithaslowrisk.Wecontrolforsystematicandidiosyncraticriskinourempirical
analyses.
4
[10:2511/3/2016RFS-hhw007.tex] Page:4 1–39
WhyDon’tAllBanksPracticeRegulatoryArbitrage
Aconstrained bank can use TruPS to increase the numerator of its Tier 1
capitalratio.2 However,itcanalsotakeactionsthataffectthedenominatorof
the ratio, that is, the risk-weighted assets. Under our hypotheses, we would
expect constrained banks to do both. Since the denominator of the capital
ratio involves risk weights, banks cannot simply increase asset risk. Rather,
weexpectconstrainedbankstoarbitragetheseriskweights.Acharya,Schnabl,
andSuarez(2013)examinesuchanarbitrage.Theystudyhowbanksuseasset-
backedcommercialpaper(ABCP)conduitstoreducerisk-weightedassetson
their balance sheets and note that these conduits transfer the assets, but not
theunderlyingrisk,frombankbalancesheets.Becausethistypeofregulatory
arbitrageentailedhighfixedcosts,itwasonlyavailabletotheverylargestbank
holdingcompanies,andalmostallofthemusedit.WhileTruPSwereavailable D
o
w
tomanymorebanksthanABCP,thosebanksthatusedABCPalsousedTruPS, n
lo
confirmingourhypothesis. ad
e
ratWheirththoaunrehqyupitoythsehsoeus,ldbbanekrsistkhiaetr manedethecnapceitaml orerequviruelmneernatbslewtiothadTvruerPsSe d from
shocks because these banks choose to take on more risk than other banks. http
WbaenkisnvwesitthigamteoroeurTrpurPeSdicitnioTniseran1dcsahpoiwtalthhaatvethaeylohwoledr.dFiisrtsatn,cweetofinddefathualtt ://rfs.o
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during our sample period. Second, we find that banks with more TruPS in fo
Tier1capitalweresignificantlymorelikelytoreceivefundsfromtheCapital rdjo
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Purchase Program, the part of the Troubled Asset Relief Program through rn
a
whichtheTreasurypurchasednewlyissuedpreferredstockofbanks,andwere ls.o
also more likely to borrow from other Fed facilities.Third, banks with more rg
a/
TruPS have significantly lower return on assets and return on equity during t O
the crisis. Fourth, during the crisis, the equity of banks with more TruPS hio
performed substantially worse than the equity of other banks, and the result Sta
isevenstrongerforbanksthathadbothasignificantamountofTruPSanda te U
significantamountofriskymortgagelendinggoingintothecrisis.Finally,for niv
e
thesubsetofbankholdingcompanieswithtradedCDScontracts,bankswith rs
more TruPS in their regulatory capital have higher CDS spreads during the ity o
n
financialcrisisperiod. A
p
We contribute to three strands of the literature. First, we contribute to the ril 2
literatureonthedeterminantsofbankcapital.Second,weaddtotheliterature 1
, 2
on the impact of capital requirements on banks and on the determinants of 0
1
6
regulatoryarbitrage.Third,wecontributetotheliteratureonTruPSandother
hybridsecurities.Alargebodyofresearchexaminesthedeterminantsofbank
capital(seeBerlin2011andThakor2014forreviews).Acommonfindingin
theempiricalliteratureisthatbankstendtoholdsignificantlymorecapitalthan
2 Tier1capitalfortheperiodwestudyincludestotalshareholders’equity,minusgoodwillandotherintangibles
(exceptformortgage-servicingrights),plusqualifyinghybridsecuritiesandnoncontrollinginterests.Perpetual
preferredstockandtrust-preferredsecuritieswerepermitteduptoaregulatorylimit(approximately15%ofa
BHC’scorecapitalforlargebanksand25%aBHC’scorecapitalforsmallbanks).SeeAppendixAforadetailed
descriptionofTier1capital.
5
[10:2511/3/2016RFS-hhw007.tex] Page:5 1–39
TheReviewofFinancialStudies/v0n02016
necessarytomeetregulatoryrequirements.Forexample,FlanneryandRangan
(2008) find that banks had capital levels that were 75% over the regulatory
minimaintheearly2000s.Bergeretal.(2008)notethatbanksactivelymanage
theircapitalratios,settargetlevelsabovewell-capitalizedregulatoryminima,
andmakerapidadjustmentstowardtheirtargets.Ourpaperaddstothisliterature
byshowingthatbanksmanagenotonlythelevelbutalsothecompositionof
theirregulatorycapitalwhencapitalrequirementsarebinding.
Other literature focuses on the relationship between bank capital and
performance. Berger (1995) finds that banks with higher capital had better
earnings in the 1980s. More recently, Mehran and Thakor (2011) also
provideevidencethatbettercapitalizedbanksperformbetter.Demirguc-Kunt,
Detragiache, and Merrouche (2013) find that before the crisis bank capital D
o
w
was not related to performance, but that during the crisis, higher capital n
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was positively related to stock performance. Beltratti and Stulz (2012) and ad
e
Fbeathwleenebnrabcahn,kPpreirlmfoermiera,nacnedanSdtuTlzier(210c1a2p)itdaolcduumrinengtthaeproescietnivtecrrieslias.tiBonesrhgiepr d from
andBouwman(2013)showapositiverelationshipbetweencapitalandmarket http
sohfabreoodkureiqnugitcyristoesa.sAselltst,hebsuetpnaopneersoffotchuesmonexeaitmheinreTtihere1incflaupeitnacleorofthTeruraPtSio. ://rfs.o
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Our paper contributes to this literature by showing that, holding the amount fo
ofcapitalconstant,bankswithmoreTruPSintheirregulatorycapitalperform rdjo
u
worse and are more likely to need government assistance during the crisis. rn
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Acharyaetal.(2012)showthatthequalityofbankcapitalinlargeinternational ls.o
banksdeterioratedpriortothecrisis. rg
a/
There is also a literature documenting that banks engage in regulatory t O
arbitrage.Infact,thefirstworkingpaperoftheBaselCommitteeonBanking hio
Supervision concluded “banks have learnt how to exploit the broad brush Sta
natureoftherequirements[…].Forsomebanks,thishasprobablystartedto te U
underminethemeaningfulnessoftherequirements.”(Jackson1999).However, niv
e
mostliteratureonregulatoryarbitragehasfocusedonshowingtheprevalence rs
andtypesofregulatoryarbitrageratherthanunderstandingwhichbanksengage ity o
n
inarbitrage.Incontrast,withTruPS,hundredsofbankholdingcompaniesin A
p
oursampleof857banksneverissuedTruPS.Becausesomanybanksdidnot ril 2
issueTruPS,itsusageisideallysuitedtostudywhysomebanksuseregulatory 1
, 2
arbitrageandothersdonot.Finally,whilethereisasmallliteratureonTruPS, 0
1
itonlypartiallyaddressestheissueswefocusoninthispaper.3 6
3 Benstonetal.(2003)examinesixty-sevenTruPSissuancesduring1996and1997.Theyfindthatthemarket
respondsfavorablytoTruPSfilings,andthatissuersofTruPSarelargerandmoresophisticatedandhavelower
economiccapitalthannonissuers.Harvey,Collins,andWansley(2003)findthattheissuanceofTruPSfrom
1996–2000hadapositiveimpactonbankstockprices,especiallyforfirmsthatusedTruPStoretirecommon
orpreferredstock.KrishnanandLaux(2005)studytrust-preferredsecuritiesissuedbybothbanksandother
corporations,andfindthattheinitialstockpricereactiontotheissuanceofTruPSispositivewhenissuersstate
aspecificreasonforissuance.BalasubramanianandCyree(2010)arguethatbanksissueTruPStochangetheir
capitalstructureorimprovecapitalratios,butnotfortaxbenefits.Finally,KimandStock(2012)showthatthe
valueofexistingtrust-preferredsecuritiesincreasedwhenbanksacceptedTARPfunding.
6
[10:2511/3/2016RFS-hhw007.tex] Page:6 1–39
WhyDon’tAllBanksPracticeRegulatoryArbitrage
1. TheBackgroundofTrust-PreferredSecurities
Trust-preferred securities (TruPS) are cumulative nonperpetual preferred
securities issued by subsidiaries (special purpose entities, or SPEs) of bank
holdingcompanies(BHCs)whosesoleassetisjuniorsubordinateddebtissued
by the BHC. The bank holding company typically purchases 100% of the
commonequityoftheSPE(whichtypicallyrepresentsabout3%ofthetotal
assetsofthetrust).TheSPEthenissuespreferredsecuritiestoinvestors.The
SPEloanstheofferingproceedsofboththecommonandpreferredsecurities
tothebankholdingcompany.Inturn,thebankholdingcompanyissuesdeeply
subordinateddeferrableinterestdebenturestotheSPE.TheSPEisstructured
asastatutorybusinesstrustandistaxedasapartnership.Quarterlyinterestpaid
D
tothetrustisusedtopaydividendstoholdersofTruPS.BHCsmaydeferthis ow
n
interestforuptotwentyquarterswithouttriggeringdefault.IftheBHCexceeds lo
a
d
thisdeferralperiod,thenoteisconsideredindefaultandbecomesimmediately e
d
dueandpayable.Interestpaidonthenotesissuedtothetrustistaxdeductible fro
m
for the BHC. Most TruPS are callable after 5 or 10 years, and all TruPS are h
mandatorilyredeemableafter30or40years. ttp
This type of security has been used by nonbank corporations since 1993 ://rfs
and is also known as monthly income preferred stock (MIPS) or quarterly .ox
fo
income preferred stock (QUIPS) (see, e.g., Engel, Erickson, and Maydew rd
1999). The first TruPS issue by a BHC did not occur until after October 21, jou
rn
1996, when the Board of Governors of the Federal Reserve System (FRB) a
ls
announcedthatbankholdingcompaniesmayincludetrust-preferredsecurities .org
upto25%ofcorecapitalinTier1regulatorycapital.Corecapitalisagrossed a/
up version of Tier 1 capital that does not reflect deductions for disallowed t O
h
intangible assets, goodwill, and disallowed deferred tax assets. Importantly, io S
thesesecuritieswouldnotqualifyasTier1capitaliftheBHCweretodirectly tate
issuecumulativenonperpetualpreferredstock.Therefore,theTruPSstructure U
n
facilitatesregulatoryarbitrage. ive
rs
From our discussions with regulators, the Federal Reserve granted Tier ity
1 status to TruPS in 1996 for several reasons. First, Basel I allowed on
A
for Tier 1 status of minority interests, making it possible for TruPS to p
qualify as Tier 1 capital, as they were classified as minority interest in the ril 2
1
equity accounts of consolidated subsidiaries under the then-valid accounting , 2
0
rules. Second, the Fed was concerned that banks would issue REIT Trust 16
Preferred and saw TruPS as a better alternative. Finally, from a competitive
standpoint,insurancecompanieswerepermittedtocountTruPSascapital,and
internationalbankswerealreadyusinghybridcapitalasTier1capital.While
the Federal Reserve allowed BHCs to include TruPS in regulatory capital,
their subsidiary depository institutions were not allowed to do so, since the
Federal Deposit Insurance Corporation (FDIC) contended that TruPS do not
provide sufficient capital support. Therefore, all TruPS issuance was at the
BHClevel.
7
[10:2511/3/2016RFS-hhw007.tex] Page:7 1–39
TheReviewofFinancialStudies/v0n02016
Frenchetal.(2010)provideadetaileddescriptionofthehistoryofTruPS.
AppendixBofourpapershowsatimelineofimportantchangestotheTruPS
marketthroughtime,frominitialapprovalofTier1statustotheDodd-Frank
Act,whichdisallowedTier1recognition.
2. Data
Ourdatacomefromseveralsources.Thecoresampleisanunbalancedpanel
of all publicly traded U.S. BHCs that report on form FR Y-9C, which is
filedquarterlyonaconsolidatedbasisbyalldomesticBHCswithover$150
million in assets ($500 million after 2006). These data are from the Federal
Reserve Bank of Chicago. Our dataset covers the period from 1996 to 2012 D
o
w
andincludes857BHCs.Dataonindividualtrust-preferredsecuritiesarefrom n
lo
SNLFinancial,aprivatedataproviderthatusesinformationfromavarietyof a
d
e
sSoNuLrceFsintaonccrieaalteusainpgrohparniedt-acroylldeacttaebdasdea.taWferosmuppfolermmsen1t0t-hKe,T1ru0P-QS,d8a-tKa,fraonmd d from
TruPSprospectuses(forpubliclytradedTruPS),foundattheSEC’sWebsite. http
ScoolmleectdsaitnafoonrmpautbiolinclyabtoraudtepduTbrluicPlySatrraedferdomprQefuearrnetdumseOcunrliitniees,.aDWeetabilseidtedthaatat ://rfs.o
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onmergersandacquisitionscomefromSNLFinancial.Stockpricedatacome fo
from CRSP. Data on Credit Default Swap (CDS) spreads are obtained from rdjo
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MarkIt. rn
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2.1 TruPSsummarystatistics a/
We have data on 1,467 separate TruPS issuances. Figure 2 shows the total t O
h
amountofTruPS,thetotalTier-1-qualifiedTruPSoutstandingbyquarter,and io
S
the proportion of BHCs that have issued TruPS. The total amount of TruPS ta
te
outstanding(Tier-1-qualifiedTruPS)forpubliclytradedBHCswasjustunder U
n
$20($20)billionattheendof1996androsetoapeakofabout$140($120) iv
e
billion in early 2010. It is evident from the figure that banks did not initially rsity
issuemoreTruPSthanwouldcounttowardTier1capital.TotalTruPSexceeded o
n
Tier-1-qualified TruPS during the financial crisis not because BHCs issued A
p
moreTruPS but because net losses during this period caused BHCs to reach ril 2
theFed-imposedTruPScorecapitalthreshold.TheproportionofBHCswith 1, 2
TruPSincreasedsignificantlyoverthesampleperiod,risingfromlessthan10% 01
6
to about 80% by the end of 2005, where it remained steady until 2010. The
increaseisparticularlypronouncedfortheyears2000–2002.In2000,Salomon
Smith Barney issued the first TruPS collateralized debt obligation, allowing
smallBHCstoissueTruPSthroughapooledstructure.SmallBHCswithless
than$1billioninassetsquicklyseizedtheopportunitytoissueadditionalTier
1 capital between 2000 and 2002. The increase is also partially caused by
increased merger activity, which reduced the number of BHCs in the sample
overtime.TheBHCsthatleavethesamplearelesslikelytohaveTruPS,since
across the entire sample of 857 BHCs, about 40% never issue TruPS.After
8
[10:2511/3/2016RFS-hhw007.tex] Page:8 1–39
WhyDon’tAllBanksPracticeRegulatoryArbitrage
140 0.90
0.80
120
0.70
100 PS
ns 0.60 Tru
billio 80 0.50 with
TruPS in $ 4600 000...234000 portion of banks
o
20 0.10 Pr D
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n
0 0.00 lo
1996 q4 1997 q4 1998 q4 1999 q4 2000 q4 2001 q4 2002 q4 2003 q4 2004 q4 2005 q4 2006 q4 2007 q4 2008 q4 2009 q4 2010 q4 2011 q4 2012 q4 aded fro
m
Tier 1 qualified TruPS Total TruPS Proportion with TruPS
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TFoigtaulream2ountofoutstandingtrust-preferredsecurities ://rfs
Thefigureshowsthetotalamountofoutstandingtrust-preferredsecurities(TruPS)byquarterduringoursample .ox
period.ThesolidbarsshowthetotalamountofoutstandingTier-1-qualifiedTruPS,andtheshadedbarsshow fo
thetotalamountofoutstandingTruPSinbillionsofdollars(left-handy-axis).Theblacklineshowsthefraction rd
ofsamplebanksthathaveissuedTruPS(right-handy-axis). jou
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Dodd-Frankwasenactedinthethirdquarterof2010,qualifiedTruPSdropped rg
from$120billiontojustunder$100billionbythefirstquarterof2012.The at O/
moresignificanteventwasaNoticeofProposedRulemaking(NOPR)onJune h
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7, 2012, which reiterated the Dodd-Frank requirement that BHCs with over S
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$15billioninassetsphaseouttheirTruPSinTier1capitaloverathree-year te
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periodbeginninginJanuary2013,andthatbanksbetween$500millionand$15 n
iv
billioninassetsphaseoutTruPSovera10-yearperiod.4 ManyBHCstreated ers
theNOPRasa“qualifyingevent”thatallowedthemtoredeemTruPSpriorto ity
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the call date. MostTruPS include a provision allowing immediate call in the n A
cbaesdeeoefmaeqdutaoliofyccinugri“ft,afxororexreagmuplaleto,rTyruePveSnlto.”stAthtaexirotarxr-edgeudluatcotirbyileivtyensttawtuosuoldr pril 2
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nolongerqualifiedasTier1capital.Duringthelastthreequartersof2012,total , 2
0
1
qualifiedTruPSdroppedanother$40billion,endingatjustunder$60billion 6
attheendof2012.
Figure 3 shows a histogram of the outstandingTruPS as a fraction ofTier
1 capital for our sample of bank holding companies (BHCs) between 1996
and 2007, conditional on a bank having TruPS outstanding in the respective
4 OnJuly2,2013,theFed’sFinalRulesallowedbankswithassetsbelow$15billiontopermanentlytreatTruPS
asAdditionalTier1Capital,contradictingthe10-yearphase-outrequirementoftheJune7,2012NOPR.Our
dataendin2012,beforethisFinalRulewasannounced.
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TheReviewofFinancialStudies/v0n02016
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FHiigsutorger3amofTruPS/Tier1 ://rfs.o
Tfohreofiugrusaremsphloewosfbaahniksthooglrdaimngocfothmepoauntisetsan(BdiHnCgst)rubsett-wpreeefner1re9d96seacnudri2ti0e0s7(,TcrounPdSi)tiaosnaalforancatiboannokfhTaiveirn1gcTarpuiPtaSl xford
outstandingintherespectiveyear.BHC-yearobservations(106)withtotalassetsinexcessof$250billionare jo
excludedfromthefigure.ThisisdonebecauseadifferentregulatoryTruPS/Tier1limitappliestothem. urn
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year.5Figure3demonstratesthatthereisawidecross-sectionaldistributionof rg
TruPS/Tier1ratios;whileTruPSusageissubstantial,bankholdingcompanies at O/
donottypicallyissuethemaximumpossibleamount.Thehistogramsuggests h
io
that banks choose an amount of TruPS/Tier 1 that is optimal for them, and S
ta
thisisconsistentwithourhypotheses.Notethatwhilethereissomeclustering te
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ofTruPS/Tier1atthe25%threshold,therearemanyBHC-yearobservations n
iv
with more than 25% TruPS in Tier 1 capital. French et al. (2010) point out ers
that this is not inconsistent with regulatory limits. The maximum amount of ity
o
allowable TruPS is based on TruPS/core capital, not TruPS/Tier 1 capital. n A
Sgoinocdewciollr,edciaspaliltoalwdeodesdenfoetrrreefldetcatxdeadssuecttsi,onasndfoortdhiesraldloewduecdtiionntasn,gTirbulePSassmeatsy, pril 2
1
legallycomprisemorethan25%ofactualTier1capital.6 , 2
0
1
PanelAofTable1providesdetaileddataattheTruPSissuancelevel.The 6
largestnumberofsecurities(209)wasissuedin2003,withthehighestdollar
5 Thedataunderlyingthehistogramexclude106BHCfirm-yearsforinternationallyactivebanksbecausea
differentregulatoryupperlimitforTruPS/Tier1appliestothem.Sincetherearesofewobservations,their
inclusioninthehistogramwillnotsignificantlychangethedistribution.Weonlyshowthehistogramfrom1996
to2007,becausebanksdidnotissueTruPSduringthecrisisandstartedredeemingthemafterregulatorychanges
in2010.
6 Notethatitisnotpossibletocalculatecorecapitalforthewholesampleduetodataavailability,whichexplains
whywefocusonTier1instead.
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