JPMorgan To Save Millions From Fed’s Stance On Trust Preferred Securities

The country’s biggest lenders stand to gain from one of the Federal Reserve’s recent rules regarding trust preferred securities (TruPS) in a big way – with JPMorgan (NYSE:JPM) and Citigroup (NYSE:C) using it to plan recalls of as much as $16 billion worth of these high interest rate securities. ^[1] The banks jumped on the opportunity to save millions in interest payments while at the same time getting rid of the securities which are currently classified as Tier 1 capital, but would no longer be recognized so once stricter regulatory norms come into force.

We have a price estimate of $48 for JPMorgan’s stock, which we are in the process of reviewing to factor in the effect of the series of events triggered by the trading loss.

See our full analysis of JPMorgan

TruPS Have Outlived Their Utility For Banks

Banks started issuing TruPS on a large scale just prior to the economic crisis of 2008 when interest rates were much higher. And to attract more investors in booming times, banks also set generous coupon rates for these securities. Estimates of the current outstanding value of TruPS originated by U.S. banks stands at $120 billion, of which nearly a quarter pay coupons in excess of 6.25%. ^[1]

With current interest rates at record lows, these securities are an unnecessary burden on banks. And the best option for the banks is to retire them. This is where the Fed’s new rule governing them comes in.

Killing Two Birds With One Stone

TruPS contracts normally contain a condition which allows the issuing bank to retire them early if their status under new capital rules changes. With the Fed pushing for the phasing out of TruPS from banks’ balance sheets as a Tier 1 capital source, banks finally have the reason they need to get rid of them.

And we are not talking about small changes here. JPMorgan currently has almost $15 billion worth of TruPS with coupon rates of more than 6%. The bank would save almost $650 million in annual interest payments if it retires its TruPS.

This would reflect through an improvement in the bank’s trading yields shown above.

No doubt, once the TruPS are bought back the banks will need to raise new capital. But this would in turn provide them an opportunity to issue securities which not only cost them less in terms of interests paid, but which also would be considered a part of Tier 1 capital – allowing them to meet regulatory requirements.

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1. US banks take advantage of capital rules, Financial Times, Jun 17 2012 [↩] [↩]