TruPS Change to Impact Bank Capital Policies for Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC)

The Financial Regulatory Reform Act is said to be a watered down version of the original legislation – however, that does not mean it is impotent.

In legislation such as this, the minutia is of critical importance. In this case, the so-called “Collins Amendment” addresses the capital levels of banks, a critical component to sustaining a run and ensuring stability of the financial system. Although this component will not directly change capital levels, it will have a large impact on the large banks in particular.

Senator Collins (R., Maine) has supported the provision, which will prevent banks with more than $15 billion in assets from using TruPS as part of their key Tier 1 capital levels. As a result, smaller banks, which tend to rely heavily on TruPS as a capital crutch, will not be affected.

As the research community pores over this legislation and the impact, news has begun to trickle out. RBC Capital Markets, for example has stated in analysis that there are several major banks that have heavy exposure to TruPS. The banks will need to replace TruPS with other types of core capital, either retained earnings or equity.

The four largest banks, Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC) will need to replace over $86 billion among them. As such, there’s a potential for considerable new stock issuance and additional dilution if big banks decide to act quickly to replace trust-preferreds without divesting assets, or if they’re unable to generate cash that quickly through core earnings.

This change will not take place immediately, as the banks are expect to have up to five years to phase-in the requirement. The RBC analysts expect them to rely mostly on retained earnings. The analysts, led by Gerard Cassidy, indicated that other means of capital generation — such as converting hybrid securities into common equity — may be dilutive as well.

Cassidy commented, “As many banks currently rely upon hybrid securities to support their core capital requirements, these new revisions prevent a scenario whereby banks would be required to commence near-term dilutive offerings to replace the hybrid securities. The final amendment allows banks to internally generate capital during the phase-out period, which should help mitigate future capital raises.”

Bank Capital may not be an issue depositors ponder, but to the regulators and bank management, this is of paramount importance. Any change to Tier 1 Capital, even if it is self funded through Retained Earnings, will likely have large implications of firms, in particular, raising internal WACC’s across the spectrum.