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TruPS and Involuntary Bankruptcy

One of the most dramatic tools a lender can use in the collection of a loan is the involuntary bankruptcy case.  It is dramatic because of the implications for both the debtor and the lender who files the case. If a bankruptcy court determine that the petitioning creditor has not met the statutory requirements it may require the creditor to pay the debtor’s costs and attorneys fees in defending the petition and if the court finds that the petition was filed in bad faith it can award compensatory and punitive damages.  The consequences for the debtor are that if the creditor is successful, the debtor’s business and assets are now subject to disposition under a frameworks found in the Bankruptcy Code which may involve the appointment, at least initially,  of a bankruptcy trustee to administer the debtor’s estate.  Even if the debtor is successful in fighting off the petition it may suffer dramatic reputational risks that might affect its continued viability. Think of it then as the “nuclear” option.

This tool has now been used at least twice in connection with the enforcement by holders of Trust Preferred Securities (“TruPS”) against bank holding companies (“BHCs”). TruPS are hybrid securities that are included in regulatory tier 1 capital for BHCs and whose dividend payments are tax deductible for the issuer. In 1996 the Federal Reserve Board’s decided that TruPS could be used to meet a portion of BHCs’ tier 1 capital requirements. Following that decision many BHCs found these instruments attractive because of their tax-deductible status and because the increased leverage provided from their issuance can boost return on equity.

Smaller BHC’s typically did not bring TruPS to the market themselves, rather they were issued into a collateralized debt obligation (“CDO”) which in turn purchased TruPS from many different BHCs. According to Fitch since 2000 over 1,800 entities issued roughly $38 billion of TruPS that were purchased by CDO’s. In addition, many federally insured institutions held TruPS themselves once the banking regulators determined that TruPS were an acceptable investment.

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Comments on Proposed Rules for Georgia Fairness Hearings

On May 9, 2014, the Georgia Securities Division issued a proposed rule to create a formal process for fairness hearings to be conducted by the Georgia Commissioner of Securities.  The proposed rule would establish procedures for administrative hearings to determine the fairness of certain mergers and other business combinations in which securities are issued.  If the Commissioner determines that the terms of the proposed transaction are fair to the shareholders receiving securities, the issuer would be able to claim an exemption from the registration requirements of the federal Securities Act of 1933 for the securities to be issued.  Specifically, Section 3(a)(10) provides an exemption from the registration requirements of the federal Securities Act for securities issued in a transaction determined to be fair pursuant to a fairness hearing by a governmental authority.  The exemption from registration with the SEC is particularly valuable for companies that are not currently subject to the periodic reporting requirements under the Securities Exchange Act of 1934.

In our view, fairness hearings conducted by the Georgia Commissioner will make it easier for private bank holding companies to use stock to fund the purchase price for acquisitions.  Not only will the hearing process allow companies to avoid filing a Form S-4 registration statement for the acquisition with the SEC, it will also allow the companies to avoid triggering the significant ongoing expense associated with the periodic reporting and disclosure requirements of the Securities Exchange Act of 1934 and the Sarbanes-Oxley Act.  We have seen circumstances in which the registration and ongoing reporting requirements have discouraged a company from using stock as a currency for an acquisition.

States such as California and North Carolina have conducted state fairness hearings similar to those described in the proposed rule for some time.  Following the re-write of the Georgia Securities Act in 2008, Georgia has only conducted one fairness hearing, which involved the merger of two financial institutions in late 2013. The proposed rule would provide more clarity and certainty with respect to the fairness hearing process in Georgia.

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The Upcoming Trust Preferred Interest Deferral Cliff

While we continue to emerge from the Great Recession, we are also approaching another cliff that could have significant ramifications for many community banks that continue to defer interest payments under their Trust Preferred securities.  Under the terms of such Trust Preferred, issuers are generally allowed to defer interest payments for up to twenty consecutive quarters (or five years) without triggering a default.  Many institutions began deferring interest payments about four and half years ago, both to preserve capital generally and in reaction to Federal Reserve Bank enforcement actions that limited the ability of banks to pay interest on the subordinated debt supporting the Trust Preferred.  As we approach the end of the permitted five-year deferral period, we are now assisting a number of clients, on all sides of the equation, in addressing the ramifications of approaching, and potentially ultimately exceeding, the five-year deferral period.

One issue we have looked at is whether the Federal Reserve will permit a bank holding company subject to an enforcement action to bring its Trust Preferred current when failure to do so would result in default.

We’ve looked at the language in a number of agreements hoping that it would prohibit bank holding companies from paying interest only when such interest can be contractually deferred.  Unfortunately, all the enforcement actions that we reviewed have a blanket prohibition on interest payments without regard to the permissibility of the deferral under the indenture.  We understand that the Federal Reserve Banks are looking closely at the issue but have not yet provided any guidance as to the ultimate position on payment.  In addition, most bank holding companies seeking to pay interest will need a dividend from their subsidiary bank to fund such payment; accordingly, the bank level regulator(s) will likely need to be involved as well.

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BASEL III: The Final Rules are Here and It’s Time to Get Ready

Over the past year, my colleagues and I have spent an untold number of hours researching, writing and speaking about the Basel III capital rules. We felt it important to help bankers focus on the proposed rules in order to help them prepare and to help facilitate an appropriate response to the proposed rules. Because the rules were in proposed form, however, many bankers, bank directors and industry participants did not focus on these capital rules, instead waiting until they were finalized. Well, we’re here.

Earlier this month, the regulatory agencies finalized their revisions to the capital and risk-weighting rules, commonly known as the Basel III rules. Even though the rules will not be effective for most banks until Jan. 1, 2015, the finalizing of these rules presents the call to action to begin the dialogue about how the new rules will impact your bank. Of course, given the fact that the final release for the rules was almost 1,000 pages long, many bankers contemplating a board presentation are left to ask, “Where should I start?” Below are a few suggested areas of focus to begin to enhance your directors’ understanding of the new rules. 

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SEC Adopts Final Rules to Rule 506 Private Placements

The SEC recently adopted new rules to lift the ban on general solicitations and general advertising for Rule 506 private placements and Rule 144A offerings. In addition, the SEC also adopted rules disqualifying “bad actors” from taking advantage of the Rule 506 private placement safe harbor. These new rules will be effective on September 23, 2013. The SEC has further proposed new rules that, among other things, require an SEC filing at the start of Rule 506 placements involving general solicitation, the inclusion of additional cautionary legends and disclosures in offering materials as well as a temporary (two-year) requirement to file general solicitation materials with the SEC.

Regulation D’s Rule 506 provides a safe harbor exemption from registration under the Securities Act of 1933 for private offerings made to accredited investors and no more than 35 non-accredited investors who meet certain investment sophistication requirements. The SEC estimates that Rule 506 offerings account for more than 90% of all Regulation D safe harbor private offerings and substantially all of the capital raised under Regulation D. Prior to these new rules, an offering would not satisfy the Rule 506 safe harbor exemption if any general solicitation or general advertising occurred. General solicitation and advertising includes advertisements published in magazines and newspapers or broadcast by television or radio or made available through unrestricted websites. Widely disseminating offering materials absent pre-existing relationships with investors may even be deemed a general solicitation.

General Solicitation Ban Removed

As mandated by the JOBS Act (to be completed by July of last year), the SEC is adding new Section 506(c) to permit general solicitation and advertising to offer and sell securities in a Rule 506 offering if (a) all purchasers are accredited investors or the issuer reasonably believes that they are accredited investors, and (b) the issuer takes reasonable steps to verify that all purchasers are accredited investors.

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June 30th Deadline Fast Approaching; Delaware’s New VDA Program Offers Maximum Benefits To Companies Organized in Delaware

The first deadline – June 30, 2013 – under Delaware’s new unclaimed property Voluntary Disclosure Agreement (VDA) program is fast approaching! This initial deadline offers the maximum program benefits to VDA participants: Prior to the new VDA program, holders were required to report and remit any past due unclaimed property starting in 1981. However, holders who enter into the new VDA program by June 30, 2013 qualify for a limited look-back period through 1996. Holders who sign up by June 30, 2014 qualify for a look-back period through 1993.

For those who may not be aware, Delaware’s new VDA program is an amnesty program primarily aimed at helping non-compliant companies become compliant under the law. The business-friendly program is run by the Department of State, and is designed so companies can “catch up” on their past due unclaimed property obligations, avoid interest and penalties, and significantly reduce their unclaimed property liability. Completion of the program also offers companies a full release of all past due unclaimed property liability in a reasonably short and efficient process.

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IRS Reverses Position to Allow Expensing of Foreclosure Costs

The Office of Associate Chief Counsel (Income Tax & Accounting) recently released a memorandum (the “Chief Counsel memorandum) that holds that a bank that acquires OREO through foreclosure proceedings (either through actual proceedings or by deed-in-lieu of foreclosure) with respect to a loan originated by the bank is not considered to acquire the OREO for resale within the meaning of §263A of the Internal Revenue Code and the applicable Treasury Regulations thereunder. This Chief Counsel Memorandum contradicts, at least in part, a memorandum issued last June by Associate Area Counsel (Detroit) (Large Business & International) (the “Area Counsel Memorandum”) that concluded that certain OREO acquired through foreclosure, which was held solely for resale and not for the production of rental or investment income, was considered to be acquired by a bank for resale within the meaning of §263A and the underlying regulations. Accordingly, the previously issued Area Counsel Memorandum concluded that acquisition costs incurred in connection with the foreclosure proceedings, such as legal fees and other direct costs incurred in connection with the foreclosure, as well as certain production costs incurred while holding the property for resale, including real estate taxes, insurance, repairs, maintenance, capital improvements, and utilities, had to be capitalized in whole or in part and in effect recovered as part of the basis of the OREO when computing gain or loss on the sale of the OREO.  (Print Version of this Alert Available.)

The rationale for the conclusion in the Area Counsel Memorandum is that the bank clearly acquired the foreclosed property for resale since the federal and state regulations generally restrict the period that OREO may be held by a bank (although extensions can be granted) and also require that banks make good faith efforts to dispose of the OREO. The Area Counsel Memorandum reached this conclusion even though federal and state regulations would not have allowed the bank to otherwise acquire and deal in such property as a business carried on to make a profit. The Chief Counsel Memorandum takes a different view of the activities that generally must be carried on in order for a taxpayer to fall under the capitalization provisions of §263A, which is whether the bank is acquiring property with a view to re-sell it at a profit as part of the bank’s normal business activities. The Chief Counsel Memorandum concludes that the bank is acting in its capacity as a lender and not a traditional reseller of real property. The bank is economically compelled to acquire the property as a last resort to recover funds that it originally loaned in order to minimize its losses.

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2013: A Window of Opportunity for S Corporation Asset Sales

In general, when an S corporation sells its assets, the gain on sale flows through to, and is reportable by, the shareholders and is not subject to a corporate level tax.  In the case of an S corporation that previously was a C corporation, however, such S corporation is subject to a corporate level tax on its “built-in gain” if the asset sale occurs during the “recognition period.”

Generally, an asset’s built-in gain is the amount of gain that would be recognized if the corporation sold such asset immediately before it converted to an S corporation and the recognition period is the first ten years following the conversion to an S corporation.  The recognition period was shortened to seven years for sales occurring during a taxpayer’s 2009 and 2010 tax years and to five years for sales occurring during a taxpayer’s 2011 tax year.  The recently enacted American Taxpayer Relief Act of 2012 extended this shortened five-year recognition period for any built-in gains recognized during either the 2012 or 2013 tax years.  For the 2014 and later tax years, the recognition period will again be ten years, unless legislation to the contrary is passed before then.  Thus, an S corporation that converted from a C corporation at least five years ago should consider the tax benefits of an asset sale occurring in 2013 to avoid the corporate level tax on built-in gain.

If you would like to discuss how this matter may affect your bank, please contact a member of Bryan Cave’s Financial Institutions or Tax Advice and Controversy client service groups.  We also encourage you to attend our 2013 S-Corp Conference.

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Around the Web

Around the Web

November 11, 2012

Authored by: Robert Klingler

A collection of new banking resources from around the internet:

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Around the Web

Around the Web

September 30, 2012

Authored by: Robert Klingler

A collection of new banking resources from around the internet:

  • BASEL III Regulatory Capital Calculator – The federal banking regulators released this regulatory capital estimation tool to assist community banks evaluate the proposed BASEL III capital rules.
  • SEC Disclosure Guidance for Banks – The SEC used this slide presentation in a presentation to the 2012 AICPA National Conference on Banks and Savings Institutions.
  • FDIC Revised Approach to Citing Violations in Examination Reports – This Financial Institution Letter (FIL-41-2012) describes how the FDIC will permit examiners to distinguish the severity of violations identified in call reports, with a goal of allowing institutions to appropriately prioritize efforts to address issues identified during the examination.
  • Case-Shiller July 2012 Home Price Indices – Case-Shiller has released its July update to the Case-Shiller Home Price Indices, showing average home prices increased by 1.6% in July versus June 2012.
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