Alert May 26, 2009

FRB Adopts Final Rule on Treatment of Senior Preferred Shares Issued to the Treasury under the TARP Programs and Adopts Interim Rule Concerning Capital Treatment of Subordinated Debt Issued by Mutual and Subchapter S Bank Holding Companies

Final Rule on Capital Treatment of TARP Senior Preferred Stock.  The FRB adopted a final rule (the “Rule”) on the treatment of senior perpetual preferred shares (“Senior Preferred Shares”) issued to the Treasury pursuant to the Troubled Asset Relief Program’s (“TARP”)  Capital Purchase Program as well as under the TARP’s Targeted Investment Program, Capital Assistance Program and Asset Guarantee Program (collectively, the “TARP Programs”).  The Rule permits bank holding companies to include without limit all Senior Preferred Shares issued under the TARP Programs in Tier 1 capital for purposes of the FRB’s risk-based and leverage capital rules and guidelines for bank holding companies.  The Rule leaves largely unchanged and makes final the interim final rule (the “IF Rule”) discussed in the October 21, 2008 Alert.

The FRB noted that, without the relief provided by the Rule,  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.  As noted in the IF Rule, the terms of the Senior Preferred Shares call for an initial dividend rate of 5%, which increases to 9% after five years.  The FRB noted in the IF Rule that it has long expressed concern that a step-up dividend rate undermines the permanence of a capital instrument and poses safety and soundness concerns.  In issuing the Rule, 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.  In the IF Rule, the FRB strongly cautioned 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 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. 

Interim Rule for Subchapter S and Mutual Bank Holding Companies.  In addition, in a separate release, the FRB adopted an interim final rule (the “Interim Rule”), which permits Subchapter S bank holding companies and bank holding companies organized in mutual form to include new subordinated debt securities issued to the Treasury under the TARP in their Tier 1 capital, provided that the subordinated debt securities will count toward the limit on the amount of other restricted core capital elements includable in the applicable bank holding company’s Tier 1 capital.

The Rule and the Interim Rule will be effective on the date they are published in the Federal Register.  The FRB seeks public comments on the Interim Rule within 30 days of the Interim Rule’s publication in the Federal Register.