Alert October 21, 2008

FRB Adopts Interim Final Rule on Treatment of Senior Preferred Shares Issued to the Treasury under the TARP Capital Purchase Program

The FRB adopted an interim final rule (the “Rule”) on the treatment of senior perpetual preferred shares (“Senior Preferred Shares”) issued to the Treasury pursuant to the TARP Capital Purchase Program (the “CPP”).  For a complete discussion of the CPP, please see the discussion in the October 14, 2008 Alert.  The Rule specifically permits bank holding companies to include without limit all Senior Preferred Shares issued under the CPP in Tier 1 capital for purposes of the FRB’s risk-based and leverage capital rules and guidelines for bank holding companies.

The FRB noted that some features of the Senior Preferred Shares would otherwise render it ineligible for Tier 1 capital treatment or limit its inclusion in Tier 1 capital under the FRB’s capital guidelines for bank holding companies.  The amount of cumulative perpetual preferred stock that a bank holding company may include in its Tier 1 capital is currently subject to a 25 percent limit.  Further, bank holding companies may not include in Tier 1 capital perpetual preferred stock, whether cumulative or non-cumulative, that has a step-up dividend rate.  The terms of the Senior Preferred Shares call for an initial dividend rate of 5%, which increases to 9% after five years.  The FRB has long expressed concern that a step-up dividend rate undermines the permanence of a capital instrument and poses safety and soundness concerns.  The FRB recognizes, however, that Senior Preferred Shares are being issued with the strong public policy objective of increasing capital available to banking organizations and include features designed to incentivize issuers to redeem Senior Preferred Shares and replace such shares with private qualifying Tier 1 capital as soon as practicable.  A bank holding company may only redeem Senior Preferred Shares with the approval of the FRB.   The FRB strongly cautions bank holding companies against construing the inclusion of Senior Preferred Shares in Tier 1 capital as in any way detracting from the FRB’s longstanding stance regarding the unacceptability of a rate step-up in other regulatory capital instruments.

The FRB stated that it expects bank holding companies that issue Senior Preferred Shares to hold capital commensurate with the level and nature of the risks to which they are exposed.  The FRB further expects such bank holding companies to appropriately incorporate the dividend features of the Senior Preferred Shares into their liquidity and capital funding plans.

The Rule was effective October 17, 2008; however, the FRB is seeking public comment on the Rule.  Comments must be submitted within 30 days of the publication of the Rule in the Federal Register, which is expected soon.