On June 13, 2011, the Federal Reserve published an interim final rule nominally offering some relief from the capital effects of the Tier 2 treatment for SBLF funds for Sub S and Mutual bank holding companies.

As recognized by the Federal Reserve, “the SBLF Subordinated Securities, like the CPP Subordinated Securities, are issued to Treasury as part of a nationwide program to provide capital to eligible banking organizations that are in generally sound financial condition in order to increase the capital available for lending to small businesses, thereby mitigating the ongoing effects of the financial crisis on small business and promoting financial stability.”  The Federal Reserve also acknowledged that “the SBLF Subordinated Securities are in terms and substance substantially equivalent to the CPP Subordinated Securities.”  Not withstanding these goals and similarities, the SBLF Subordinated Securities will only be eligible for Tier 2 capital treatment, as required by the Collins Amendment portion of the Dodd-Frank Act.

Notwithstanding the Tier 2 treatment, as a result of the Small Bank Holding Company Policy Statement, small bank holding companies (less than $500 million in consolidated assets) can still downstream the SBLF funds as Tier 1 capital into their subsidiary bank(s).  By adopting this rule, the Federal Reserve confirmed that a Sub S or Mutual BHC that otherwise qualifies for the small banking holding company policy statement will not have to treat the SBLF funds as “debt” for purposes of complying with the policy statement (which limits the ability to pay dividends if the debt to equity exceeds certain ratios.

For Sub S or Mutual bank holding companies with more than $500 million in consolidated assets, it’s very difficult to rationalize why they would seek to convert their CPP Subordinated Securities (Tier 1) into SBLF Subordinated Securities (Tier 2).  For all other groups of institutions, the capital treatment between TARP and SBLF either remains the same or is functionally irrelevant due to the Small Bank Holding Company Policy Statement.

As a side note, it’s now been 600 days since President Obama first floated the idea of providing additional capital to community banks to spur lending for community banks, 502 days since President Obama included the idea in his State of the Union Address (to a standing ovation from both sides of the aisles), and 174 days since the Treasury released the SBLF term sheet and application.  We are not aware of any SBLF fundings, much less approvals.  So much for “mitigating the ongoing effects of the financial crisis on small business and promoting financial stability.”