July 17, 2012
Authored by: Jonathan Hightower
As the industry gains a greater understanding of the proposed Basel III capital rules, some management teams are identifying potential problems for their organizations in the rules. One such problem is the broad-based dividend restrictions and the consideration of how those restrictions may impact S Corporations.
Many states recognize in their banking laws and regulations that a different set of standards should apply in determining dividend restrictions for S Corporation banking institutions and their holding companies. Because the taxable income of these entities is passed through to the shareholders of the organization, it is expected that these entities will pay distributions that allow their shareholders to fund their personal tax liabilities attributable to the taxable income of the organization.
The proposed Basel III capital rules have a number of dividend restrictions. Most bankers are familiar with the dividend restrictions imposed under Prompt Corrective Action, but the new capital rules also contain dividend restrictions if the organization is not in full compliance with the requirement to maintain the required capital conservation buffer: a requirement for banking organizations to maintain common equity Tier 1 capital equal of 2.5% of total risk-weighted assets in addition to the minimum risk-based capital requirements.
If a banking organization does not maintain the full capital conservation buffer, it becomes subject to restrictions on the payment of dividends and on payments of discretionary bonuses to executive officers. These restrictions increase as the organization’s capital conservation buffer decreases, and if the organization does not maintain a capital conservation buffer of at least 1.25% of risk-weighted assets, it will be able to pay dividends of no more than 20% of its eligible retained income in dividends, subject to receiving a waiver of these restrictions from its regulators. Eligible retained income is defined as the organization’s net income for the previous four quarters, net of dividends and discretionary bonus payments to executive officers during that period.