June 28, 2010
Authored by: Barry Hester and Bryan Cave
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.
First, Section 171(b)(5) fully exempts from the new standards: (1) securities issued to the federal government pursuant to the TARP program prior to October 4, 2010; (2) any Federal Home Loan Bank; and (3) holding companies subject to the Federal Reserve’s policy statement on small bank holding companies (generally, holding companies with less than $500 million in assets). Importantly, the securities of any small bank holding company not otherwise exempted would become subject to heightened capital standards if its assets grew to beyond $500 million.
Second, Section 171(b)(4)(C) grandfathers securities issued before May 19, 2010 by: (1) holding companies with less than $15 billion in assets as of December 31, 2009; and (2) by entities that were mutual holding companies as of May 19, 2010. Pursuant to this grandfather provision, these entities will be able to continue to treat these securities as Tier 1 capital subject to existing Federal Reserve limitations through the life of the securities.
Third, Section 171(b)(4)(B) provides a phase-in for securities issued before May 19, 2010 by issuers that are not eligible for the grandfather provisions discussed above. For these entities, securities issued prior to May 19, 2010 will become subject to the Dodd Frank Act’s heightened capital requirements over a three-year phase in beginning on January 1, 2013. Conversely, any securities issued on or after May 19, 2010 will be immediately subject to the Act’s heightened capital standards unless otherwise exempted or grandfathered.
One important aspect of the implementation of these capital standard changes will be left to regulatory discretion: the specific schedule for the three-year phase-in applicable to larger holding companies. On the other hand, the reference to the Federal Reserve’s small bank holding company policy statement freezes this agency position “as in effect on May 19, 2010.” Even if the Fed changes the view it expresses in this statement, this pending statute would arguably preserve going forward the Section 171 exception for holding companies with less than $500 million in assets.
Section 171(b)(6) also commissions a study by the Office of the Comptroller General on the availability of capital to insured depository institutions with total consolidated assets of $5 billion or less. The revised Section 171 preserves the requirement that federal banking regulators to develop capital requirements that address systemic risk, including the risk associated with derivative trading and asset concentration. Incorporating a House proposal, Section 165 would authorize the Act’s Financial Stability Oversight Council to impose a 15:1 leverage ratio on banks with $50 billion or more in consolidated assets that, in the view of the Council, pose a grave threat to the financial system.
Separately, the Act’s Section 616 would specifically authorize the Federal Reserve to establish capital requirements for bank holding companies and other companies that directly or indirectly control banks. This section would direct the Fed to make these requirements counter-cyclical “so that the amount of capital required to be maintained by a company increases in times of economic expansion and decreases in times of economic contraction, consistent with the safety and soundness of the company.” This concept is popular with international regulators and would in theory build reserves for financial hardship during more profitable times. In addition, Section 616 would codify a requirement that bank holding companies as well as other companies in direct or indirect control of FDIC-insured banks act as a “source of strength” in times of financial distress.