WASHINGTON — After a heated debate, the regulatory reform conference committee agreed late Thursday to scale back a provision of the bill that would eliminate the use of trust-preferred securities as Tier 1 capital.

The two sides conceptually agreed to exempt all institutions with less than $500 million of assets and grandfather existing trust-preferreds for at least some bank holding companies but Senate conferees were at odds on where best to draw the line.

At the behest of Rep. Dennis Moore, D-Kan., House conferees sought to grandfather the hybrid debt-equity instruments for all institutions, regardless of size.

But Senate conferees only agreed to do so for holding companies with less than $10 billion of assets. Larger firms, according to the Senate proposal, would face a three-year phase-in period starting in 2013.

House lawmakers argued it was wrong to retroactively alter the capital treatment of trust-preferreds. "I feel that to change the capital treatment of these Trups agreements after the purchase was already made is unfair and could negatively impact economic recovery," Moore said.

It was unclear what the final provision would look like. House Financial Services Committee Chairman Barney Frank said that the House would wait until Tuesday before offering its counter concerning the capital measure.

The capital provision was just one of several dealt with during the third day of substantive work by the committee.

The conferees also tackled whether to create a resolution fund that could be used by regulators to unwind a systemically important firm and made a final decision to remove language that would have made the head of the Federal Reserve Bank of New York a presidentially appointed position.

But the capital measure was arguably the most controversial. The banking industry has fought the original provision since it was added by Sen. Susan Collins, R-Maine, during Senate debate on the regulatory reform bill. Collins, citing concerns from Federal Deposit Insurance Corp. Chairman Sheila Bair, said trust-preferreds should not count as capital since they do not absorb losses.

Her original amendment would treat all holding companies the same, regardless of size, and would be effective immediately after the bill was enacted. The banking industry argued that would cause many banks to be undercapitalized almost overnight, potentially causing some to fail.

House and Senate conferees from both political parties agreed some transition period was needed.

House conferees had initially been expected to offer to grandfather firms with less than $15 billion of assets and force larger holding companies to phase-in requirements starting in 2013, but accepted Moore's proposal to grandfather all existing trust-preferreds regardless of institution size.

Rep. Carolyn Maloney, D-N.Y., endorsed Moore's amendment, arguing that a phase-in could still cause large banks to engage in a fire sale of trust-preferred securities.

"If these entities are forced to meet a hard-and-fast deadline of Jan. 1, 2013, they will flood the market, creating downward pressure on the price for trust-preferred stock," Maloney said.

But Senate Banking Committee Chairman Chris Dodd said the House offer went too far and noted that his staff had been working with Collins' office and that there was still a difference of opinion among Senate members.

Dodd said that the Senate could live with House language to shield the Federal Home Loan Banks and smaller banks under $500 million from the provision, but could not support grandfathering existing trust-preferreds for all institutions.

Instead Dodd said the Senate would draw the line at bank holding companies under $10 billion of assets and would strike House language that was added which would give regulators the discretion to essentially ignore the requirement for certain firms.

"We have worked with our colleague from Maine and her staff to modify the House offer on her amendment," said Dodd. "The House offer contained a provision that could potentially undermine section 171 by allowing regulators to effectively ignore its primary requirements. We would strike this provision."

Dodd acknowledged there would be further efforts to tweak the Collins language, however.

"We would modify the House offer to grandfather bank holding companies under $10 billion rather than grandfathering all bank holding companies," he said. "I realize there is a difference of opinion on that. We even have some difference of opinion I think on our side on that so I think there may be an amendment to that counter offer I'm making to you from our side."

Sen. Mike Crapo, R-Idaho, attempted to adopt the Moore amendment, and gained the support of one Democrat, Sen. Blanche Lincoln, and the other four Republicans on the committee. Although the amendment failed due to a tie 6 to 6 vote, it was unclear if the issue would be raised again and it was possible the Senate could revise its offer.

Dodd pushed back against Crapo, warning that Collins' support was critical to pass the final bill. The Maine Republican is one of only four GOP senators to support the reform bill and her vote is necessary to ensure final legislation can be enacted.

"This is the proposal our colleague, Sen. Collins from Maine, cares deeply about," Dodd said. "I am going to urge the rejection of the Crapo amendment… I would like to see us defend the Collins amendment as we go forward in negotiations with our House colleagues on this matter."

Under conference rules, House conferees can propose changes to the regulatory reform bill, which the Senate members can accept, reject, or propose a counteroffer. Once both sides agree, the final reform legislation must still be passed by the full House and Senate.

Conferees also debated whether to require large banks to prepay into a fund that could be used to help unwind a systemically important bank.

As expected, Senate conferees rejected a House effort to create a $150 billion fund. During debate on its version of the bill, the Senate scrapped a proposed $50 billion fund after Republicans argued it would effectively be a permanent "bailout" fund.

Dodd noted that 93 senators had voted to remove the fund from its version of the bill, and could not agree to restore it.

"Colleagues on both the Democratic and Republican side - although mostly on the Republican side… objected to the ex-ante fund as part of the Shelby-Dodd agreement," Dodd said. "We cannot accept the House offer because we cannot undo one of most critical agreements that passed 93 to 5 on the floor of the Senate."

But Rep. Luis Gutierrez, D-Ill., the author of the fund in the House bill, said that GOP claims made no sense.

A bailout fund "does not exist," he said. "You cannot find it in here. … This is a funeral fund. This is a dissolution fund."

Rep. Maxine Waters, D-Calif., questioned Republicans' logic, noting that the Senate bill would force the FDIC to borrow from the Treasury Department to unwind a large institution.

"Why my Republican colleagues in the Senate held up the bill because of the prefund is beyond me," she said. "Why a prefund from the industry is a taxpayer bailout but a line of credit from Treasury is not is also a mystery."

The debate came as the committee also finished dealing with issues left over from Wednesday's marathon session.

Sen. Jack Reed, D-R.I., lost his battle to force the head of the Federal Reserve Bank of New York to be appointed by the president and confirmed by the Senate.

Frank also said that the House would agree to drop a proposal to require the Fed to certify a 99% degree of confidence that its emergency loans made under its 13(3) authority would be repaid in full.

Sen. Bob Corker, R-Tenn., also succeeded in adding language to the Senate offer that would require the systemic risk council to take accounting and insurance issues into consideration when making recommendations on financial stability.

The American Bankers Association and other banking groups have argued that mark to market accounting rules contributed to the crisis and should be included in the analysis of systemic risk.

Corker also succeeded in adding a study to the Senate offer related to the Collins amendment that would require the comptroller general to study the use of different hybrid capital instruments on the banking system, specifically including the disallowance of trust preferred securities.

Frank said the House planned to respond to the Senate's offer on systemic risk, resolution and capital on Tuesday. That day was already likely to be highly charged, as conferees are scheduled to also address other controversial issues such as interchange fee regulation, consumer protection, and risk retention.

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