Possible Treats for U.S. Banks due to TLAC? and How about Europe Banks?

Via, C/S in 1st November,

The Federal Reserve released the long awaited proposals on Total Loss Absorbing Capacity (TLAC). TLAC sets the bail-in debt requirements for systemically important banks and removes the last major regulatory overhang/uncertainty for the sector.

U.S. TLAC is not as stringent as it could have been, both in terms of the requirements and the compliance period. The U.S. proposal is largely consistent with the FSB's latest guidelines, and is not gold plated for U.S. banks. A key addition is a long-term debt requirement.

Our estimated TLAC shortfall for the entire sector is $87 bn, which is ~$33 bn less than the Fed's forecast. Our estimate includes anticipated RWA/leverage reductions, progress made by banks in 3Q15, and further increases in common and preferred stock issuances for regulatory capital purposes. The new, lower shortfall estimate significantly reduces concerns around a supply wall and should be positive for credit spreads.

Wells Fargo has the biggest shortfall at $46 bn. JPMorgan ($19 bn), Citi ($14 bn), Bank of America ($6 bn), and State Street ($2 bn) all have more manageable shortfalls that could be met within a year if desired. Bank of New York, Goldman Sachs and Morgan Stanley all have surpluses.

The U.S. proposal includes a separate long-term debt requirement in addition to TLAC. TLAC consist of Common Equity Tier 1, preferred stock and qualifying long-term debt. To meet TLAC and debt requirements, securities must be issued out of the parent-level, unsecured, be plain vanilla, have a remaining maturity of more than 1 year, and governed by U.S. law. OpCo subordinated debt will not qualify as TLAC. HoldCo's are restricted from issuing short-term liabilities and entering into derivative contracts with third parties. 

Our main concern is a provision to significantly increase the capital cost for holding TLAC-eligible bank bonds, including in trading desks. This provision could further reduce market liquidity and increase the volatility of credit spreads during periods of market stress. Although regulators aim to reduce contagion risk, it could have a negative impact on financial stability. In our view, a 5-day market making holding period exemption is inadequate.

The TLAC Requirements

U.S. GSIBs face two TLAC requirements: 1) a long-term debt requirement that must be fulfilled entirely using unsecured long-term HoldCo debt, and 2) a TLAC requirement that could be met with Tier 1 capital and/or unsecured long-term HoldCo debt. Under the proposed rules, the long-term debt requirement is defined as the higher of a) 6% of RWAs plus the bank's U.S. GSIB buffer, and b) 4.5% of its leverage exposure, which is the denominator of the Basel III supplementary leverage ratio (SLR). The eight U.S. GSIB capital buffers range from 1% to 4% of RWAs. In other words, the RWA-based long-term debt requirement ranges from 7 – 10% (of RWAs) depending on each bank's systemic importance, while the leverage-based requirement is a flat 4.5% (of leverage exposure). We note that the U.S. GSIBs are required to conform to this long-term debt requirement by January 2019.

cf> How about Europe Banks?