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DM Hybrid deals: The wisdom of Wits acknowledged by the Fed

Reserve confirms Wachovia deal qualifies for tier 1. And that could spark over $40 billion of copycat deals.

Wachovia’s new $2.5 billion bank hybrid offering – Wits (Wachovia interest trust securities) – priced at the end of January, initially sparked controversy that the Federal Reserve had made a mistake in allowing the deal to qualify for tier 1 capital. But the Fed has stood by its decision to allow the structure into the tier 1 capital basket. This could prompt more innovation and more than $40 billion of new issuance.

Wits is a mandatory convertible into preferred shares after five years, on which interest payments are tax deductible. Since the mid-1990s until recently, the only tax-deductible hybrids acceptable to the Fed as tier 1 capital were trust preferred securities (Trups). Many market players believe that banks will replace some of their outstanding Trups issues as they become callable with more flexible Wits-type structures.

“Given that $35 billion of outstanding trust preferred securities will be callable within the next year, I don’t think $45 billion of issuance of hybrid capital from banks, incorporating traditional trust preferreds plus various new flavours of trust preferreds plus mandatory convertibles, is out of the question,” says Jennifer Piekut, executive director and global head of hybrids at Morgan Stanley.

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