Banks are facing yet another challenge to profits: a slew of downgrades on trust-preferred securities in their investment portfolios.
A handful of companies already have announced that they intend to take big fourth-quarter impairment charges on collateralized debt obligations that are backed by trust-preferred securities, and analysts said more banks are likely to issue similar warnings in coming weeks.
"Securities impairment charges are first and foremost on everybody's minds right now," said Damon DelMonte, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc.
Andrew W. Stapp, an analyst at B. Riley & Co., agreed. "It's becoming more and more of an issue."
The $5.8 billion-asset National Penn Bancshares Inc. in Boyertown, Pa., said last week that it expects to take an other-than-temporary impairment charge of $60 million to $65 million on pooled trust-preferred securities that it holds.
The $1.4 billion-asset Peapack-Gladstone Financial Corp. in Gladstone, N.J., is still working to determine the market value of its securities and calculate the impairment charge. Doing so is difficult because there is no market for selling them right now.
But the company said in a press release last week that the securities had an amortized cost of $67.1 million and could be worth as little as $12.7 million.
Both companies could have been facing a capital pinch as a result, if not for the Treasury Department's Troubled Asset Relief Program.
Several analysts said National Penn could have slipped below well-capitalized status on the securities impairment plus two other charges it plans to take. However, the $150 million it is getting from Treasury would be more than enough to offset its loss and still bolster its capital.
National Penn and Peapack-Gladstone declined requests to discuss the charges. (On Monday, Peapack-Gladstone announced that its chief financial officer, Arthur F. Birmingham, has resigned for health reasons and to pursue other interests.)
Banks are not only active issuers of trust-preferred securities, but active investors in them. So they are in for some pain, because the market values of the securities have declined significantly over the past quarter.
This is partly because some issuers — banks, thrifts, insurers, and real estate investment trusts — looking to preserve capital have deferred payments on the securities. (Issuers typically have the option to defer payments for five years.) Some banks also have defaulted on payments.
Though Fitch Inc. has yet to downgrade any of the trust-preferred CDOs that it rates, both Moody's and Standard & Poor's have lowered their ratings on some issues. On Nov. 12, Moody's downgraded 180 tranches of 44 trust-preferred securities.
Frank Schiraldi, an analyst at Sandler O'Neill & Partners LP, said publicly traded banks and thrifts have a median of 15.4% of their assets in an investment portfolio.
Though banks have some leeway on whether to take an impairment charge, the ratings downgrades make it more difficult to argue against taking a charge. So more banks are likely to announce charges in coming weeks, Mr. Schiraldi said.
He said some banks also have equities portfolios that are heavy on bank stocks, which could result in some future charges as well.
The impact of the securities hits on capital could be a bigger problem for investors than regulators in some cases.
Though the government cash infusion helps to bolster a company's total risk-based capital ratio, those taking securities charges would still see a decline in their common tangible equity to tangible assets ratio, Mr. DelMonte said. For example, National Penn's total tangible equity would be about 6.5% thanks to the government capital, but its common tangible equity ratio could slip to roughly 4.8%, several analysts estimated.
Investors dislike when a company's common tangible equity ratio goes below 5%, even though it is not one of the ratios that regulators require to be kept at a particular minimum level, the analysts said.
They also dislike having a wide gap between the total and common tangible equity, said Mike Shafir, an analyst at Sterne, Agee & Leach Inc.
Many of the community banks that issued trust-preferred securities are in areas hit hard by the housing market's collapse and are under pressure because of significant defaults on their real estate loans.
As of June 30, all of Peapack-Gladstone's 46 trust-preferred securities were rated investment-grade. But by Nov. 30 only half of those were still investment-grade, and Peapack-Gladstone said it expects that they too might be downgraded soon.
The $5.2 billion-asset Western Alliance Bancorp. in Las Vegas said in a Dec. 11 Securities and Exchange Commission filing that it expected to take an impairment of $65 million to $70 million after taxes on its investment portfolio for the fourth quarter.
Of the 18 CDOs that it owns, 13 are current in interest payments and five are deferring interest payments.
All are still rated investment grade, though Fitch has placed them on what it calls "rating watch negative."