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2. Banks turn to shareholder activism for new revenue source

I was tempted to start this post with a simple, "it's back," but the reality is that the private equity taxation debate never really left us.

The issue has been simmering in Washington for years now, and the private equity lobby has settled in for a long-term, if not permanent, battle. These are the sorts of issues that lobbyist live for.

The latest debate trigger was the recent White House budget proposal, which again called for an end to the current law that taxes carried interest at the capital gains tax rate, not the ordinary income tax rate. No matter what your views are on this issue, we can agree that the industry has been effective in fighting off such attempts, which have been near-constant over the past few years.

As of right now, there's no reason to think that the outcome of this proposal will be any different. Still, to buttress its case, the Private Equity Growth Capital Council has been circulating a white paper in Washington that argues that public pensions have become dependent on private equity funds to help meet future obligations. The not-so-subtle point is that taxing funds' carried interest at higher rates would simply hurt millions of middle class pensioners.

In general, tax issues will likely dog the industry for years to come. One professor has noted no fewer than 10 big loopholes. The last thing the industry wants is for the argument that it is "dependent on government subsidies" for profits to gain traction.

For more:
- here's the report

Related Articles:
New York probes private equity tax practices

Read more about: Private Equity, Taxes
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By Jim Kim

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3. In defense of regulatory capital trades

Banks are no strangers to activist shareholders, who have targeted large national banks with high-profile campaigns on several issues, such as say-on-pay and CEO/Chairman splits.

Bank executives have amassed a lot of experience in the realm of the proxy. And now, ever in need of more revenue sources, banks are aiming to leverage such expertise as a new business line. More banks, according to Reuters, are offering services to companies that are facing off with shareholder activists.

Goldman Sachs "has long been the go-to firm for companies defending against activists ever since the days when they were called corporate raiders. But over the past few years, big banks like Credit Suisse and Barclays Plc as well as investment bank Houlihan Lokey, which focuses on the middle market, have formed practices offering the services.The banks help companies with everything from writing press releases to analyzing the costs of a breakup or countering activists' demands, bankers said," Reuters said.

It noted that they also "aid companies in identifying where they could be vulnerable, even before activist investors show up on their doorsteps."

One big benefit is that the bank can solidify or form relationships with boards and top executives, which could lead to follow-on investment banking business over time. As of now, it appears to be growth market.

For more:
- here's the article

Read more about: big banks, Shareholder Activism
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By Jim Kim

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4. Citigroup touts OLA progress

The CEO of Ovid Capital Advisors has penned a strong defense of regulatory capital trades, which have been gaining in popularity.

"A bank can meet the new requirements by increasing its common equity or by reducing the riskiness of its business. The latter can be achieved by entering into a regulatory capital transaction: private investors agree to cover losses on a designated part of the bank's portfolio in return for a fee; this is similar to buying reinsurance against losses in any other business. The transaction transfers a quantum of risk of loss from the bank to a third party. The counterparty's obligation is fully collateralized with high quality assets, guaranteeing the transaction's performance. The risk to the bank of a catastrophic loss event is therefore reduced," writes the CEO in DealBook.

He also noted that, "Regulatory capital transactions offer banks a valuable tool to manage the risk of business without having to resort to selling prized assets."

The premise is generally sound, but there are circumstances under which rosy scenarios will break down.

Problems would arise, for example, if the risky loans that are being covered by the arrangement were to tank all at once. At some point, if hedge funds cannot make their required insurance payments on all the CDSs they hold as required by contract, chaos would ensue. That may seem like a remote likelihood, and some hedge funds might have bought another layer of insurance. Then again, no one expected all those CDSs on mortgage-backed securities to seize up.

For more:
- here's the article

Read more about: Regulatory Capital Trades
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By Jim Kim

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5. Bank bonds soar in face of strengthening balance sheets

The "too big to fail" controversy continues to rage, with the dramatic events in Cyprus raising the issue of "bail in" all over again.

One essential element of the Cyprus plan to save its top banks via a bail in, as opposed to a bail out. The idea is to use actual deposits (uninsured) and various debt securities to solve the recapitalization needs, essentially converting them to equity to bolster capital ratios. The virtue here is that taxpayers will not be asked to bailout the banks. Rather, the bank's customers and creditors, some of whom will be wiped out, will be asked to pony up.

In the U.S., the idea of a bail in via the Orderly Liquidation Authority (OLA), which was created by Dodd-Frank, is alive and well. The idea is place only the holding company in a type of receivership, with the options to turn unsecured senior and unsecured creditors into shareholders and subordinated debt holders of a new bridge company. That bridge company in theory would be well-capitalized and able to draw new funding, enough to facilitate a wind down.

Some think regulators will soon require more long-term holding company debt that could be converted into equity.

Citigroup has touted that it has already moved down this path, and is ahead of its peers in conforming to expected OLA requirements.

"Based on what we know now, we believe that our capital structure positions us well to adapt to potential OLA requirements, especially relative to our peer institutions, many of whom tend to run with less long-term parent-company debt than we do," an executive told analysts recently, as noted by Bloomberg.

He added that Citigroup's "bail-in components," which could be used OLA receivership, included $235 billion of different kinds of debt.

There are plenty of skeptics that the OLA has banished "too big to fail." The problem is that there's no way to test its effectiveness. We'll have to wait until the next banking crisis to know, an uncomfortable wait.

For more:
- here's the article

Related Articles:
How big bank might be wound down

Read more about: Citigroup, Bail In
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By Jim Kim

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