On July 21, 2014, the FDIC issued a Financial Institutions Letter (FIL) on the impact of the capital conservation buffer restrictions under Basel III on S Corporation banks.  The guidance essentially states that, even though Basel III restricts an S Corporation bank’s ability to pay tax distributions if it does not maintain the full capital conservation buffer, the FDIC will generally approve requests to pay tax distributions if no significant safety and soundness are present.  The succinct guidance probably raises more questions than answers.  Among those questions are the following.

  • Would a bank that does not meet the capital conservation buffer requirements ever really be 1 or 2 rated and experiencing no adverse trends?
  • Does the FDIC believe Obamacare and the related net investment income tax will be repealed?  What about state income taxes?  The factor limiting the dividend request to 40% may ignore what is actually required to allow shareholders to fund their tax liabilities.
  • What is an “aggressive growth strategy?” Is it the same as an intentional growth strategy?
  • If your institution is a national bank, a Fed member bank, or a bank holding company with more than $500 million in consolidated assets, will the Fed and the OCC follow suit and issue similar guidance?

At the end of the analysis, the guidance is probably similar to the current capital rule stating that 1 rated institutions may have a leverage ratio as low as 3.0% and still be considered “adequately capitalized.”  That rule has little practical impact in that it is awfully hard to find an institution with a 3.0% leverage ratio that is 1 rated.  Similarly, we believe any institution that meets the guidelines set forth in the FIL would almost certainly have no need to make this request.  Indeed, the FIL itself seems to acknowledge that fact.

Still, while one could mock the guidance, we would all be better served to focus, at least for a moment, on its positive aspects.  First, the FDIC should be congratulated as a first mover on this issue (we’re waiting, Fed and OCC).  Second, we are hopeful that this guidance reflects a shift in the conventional regulatory view of S Corporations.  To highlight this point, consider the following language from the adopting release for the Basel III capital rules.

“S-corporation shareholders may receive a benefit from pass-through taxation, but with that benefit comes the risk that the corporation has no obligation to make dividend distributions to help shareholders pay their tax liabilities.”

This language is similar to other comments we have heard from regulators, which expressed the view that the S election is a voluntary decision made by the institution and its shareholders and the regulatory agencies will make no distinctions between S corporations and C corporations (notwithstanding the clear and material differences).

Now, contrast the following language from the FIL.

“[T]he FDIC understands the concern that the new capital conservation buffer could increase the frequency with which S-corporation shareholders face a tax liability without having received dividends, and the concern that investors’ fear of this scenario could make it more difficult for S-corporation banks to attract capital.”

We believe that this simple but public recognition of the unique aspects of S Corporations by a regulatory agency is an important step for S Corporations.  Rather than turning a blind eye toward the impacts of the election, both positive and negative, the regulators appear to recognize and embrace the differences and, in this case, are making an effort to address the concerns.  We find that to be an encouraging starting place for S Corporations.

Given that, we believe the work of S Corporation banks and their advocates nationwide is starting to pay off in a tangible way.  S Corporations now have a man on base.  The goal should be to get him over and get him in with continuing advocacy.