After the dust settled on the work of the financial reform bill’s conference committee, Section 171 — the capital treatment provisions added by Senator Susan Collins (R-Maine) — grandfathers securities previously issued by small and mid-size bank and thrift holding companies and otherwise phases in the heightened standards. In addition, the Federal Reserve’s small bank holding company policy statement (applicable to holding companies with less than $500 million in consolidated assets) is preserved. Accordingly, the Dodd Frank Act will not impact small bank holding companies so long as they remain under $500 million in consolidated assets. Other provisions of the Act regulate systemic risk and direct the Fed to establish counter-cyclical capital requirements and to force holding companies to act as a “source of strength” for subsidiary banks.
The amended Section 171 avoids placing significant and untimely capital needs on community banks. Although we do not expect further debate on this or any other provision of the Dodd Frank Act, the reconciled bill still needs to pass both houses of Congress and be signed by the President in order to become law.
The conference report does not modify the basic policy change proposed by Senator Collins — to subject holding companies to capital requirements at least as stringent as those applicable to banks. As we have discussed, this shift would exclude trust preferred securities and TARP CPP Preferred Stock from holding company tier 1 capital totals. The impact of this change cannot be understated since banks are already struggling to retire trust preferred obligations and to generally raise capital. However, the conference committee has significantly softened the impact via grandfather provisions, blanket exemptions and transition periods.
Although the trust preferred securities (“TPS”) market has been quiet (or non-existent) for the past few years, many bank holding companies have issued TPS in the past to take advantage of the hybrid capital treatment afforded to TPS by the Federal Reserve. In 2005, the Federal Reserve revised its rules permitting the inclusion of a limited amount of TPS in the Tier 1 capital to provide stricter quantitative limits. Under the 2005 rule, which became effective on March 31, 2009, bank holding companies may include TPS in Tier 1 capital in an amount up to 25% of all core capital elements less goodwill and any associated deferred tax liability. Core capital elements include common shareholders’ equity, noncumulative perpetual preferred stock (including preferred stock issued pursuant to the Troubled Asset Relief Program (TARP)), and minority interests directly issued by a consolidated U.S. depository institution or foreign bank subsidiary. Any TPS issued in excess of this limit may be included in Tier 2 capital.
Prior to March 31, 2009, bank holding companies were permitted to calculate the limit for TPS without deducting goodwill and associated deferred tax liability from Tier 1 capital. The regulators are now taking note that some bank holding companies with outstanding TPS have not revised their Tier 1 calculations to comply with the newly-effective rule. If your bank has a holding company with outstanding TPS, be sure that you are limiting the TPS component of Tier 1 capital to 25% of core capital elements less goodwill and any associated deferred tax liability.
In addition, in the current economic environment, many bank holding companies are experiencing deterioration in capital. When the core capital elements of Tier 1 capital decline, the amount of TPS that may be included in Tier 1 capital also declines, thereby further reducing a bank holding company’s leverage ratio. When calculating capital ratios, bank holding companies must remember to re-evaluate the inclusion of TPS in Tier 1 capital as capital declines.