Finance Seminar – Joint with SAFE
Speaker: Rüdiger Fahlenbrach, École polytechnique fédérale de Lausanne
Title: Trusted preferred securities and regulatory arbitrage
Anstract: Since 1996, U.S. bank holding companies could increase their Tier 1 capital not only by issuing dilutive common equity but also by issuing non-dilutive trust preferred securities (TPS). TPS are cumulative non- perpetual preferred securities issued by non-consolidated subsidiaries of bank holding companies whose sole asset is junior subordinated debt issued by the bank holding company. TPS count as debt for tax purposes but as Tier 1 capital for regulatory purposes. Bank holding companies quickly adopted TPS, with issuance outpacing common equity issuance each year from 1999-2008. By June 2007, over 80% of bank holding companies had TPS worth $140 billion in aggregate, comprising nearly 20% of Tier 1 capital. We investigate why bank holding companies issue TPS, and find strong evidence that they primarily use TPS to maintain their Tier 1 capital ratios during periods of rapid growth. We argue that the regulatory arbitrage opportunity afforded by TPS allowed banks to grow too quickly during the 2000s, resulting on average in worse stock and operating performance during the recent financial crisis.