The Senate-approved version of the Restoring American Financial Stability Act of 2010 raises many issues for community banks.  Provisions added to it by the amendment of Senator Susan Collins (R-Maine), however, are drawing special attention.  The full text of the amendment can be found as Section 171 of the Senate-approved legislation.  The Senate unanimously consented to Senator Collins’ amendment by voice vote on May 13, 2010.

The amendment requires the various federal banking regulators to establish minimum leverage and risk-based consolidated capital requirements for all banks, all bank holding companies, and those non-bank financial firms subject to regulation by the Federal Reserve, regardless of size, that are no less than the capital requirements currently in effect for banks.  While unstated in the legislation, this amendment has two primary effects on community banks.  First, it eliminates the current regulatory exemption from consolidated capital requirements available to bank holding companies having less than $500 million in assets. Second, it would exclude trust preferred securities and bank holding company TARP CPP Preferred Stock from the consolidated Tier 1 treatment of bank holding companies.

The elimination of the small bank holding company exemption puts additional pressure on community bank holding companies to raise capital through the sale of common stock, as such holding companies will no longer merely need to assure that cash is down-streamed into the bank as Tier 1 capital.  However, for purposes of complying with regulator-mandated higher capital requirements at the bank level (whether by memorandum of understanding, IMCR, formal agreement or consent order), the treatment of the capital at the holding company level will continue to be of less importance than the treatment at the bank level.

Under the current regulations, subject to certain limitations, both trust preferred securities and TARP CPP cumulative preferred stock are treated as Tier 1 capital for bank holding companies.  However, neither are treated as Tier 1 capital if issued by a depository institution directly.  (The TARP CPP securities issued directly to banks without holding companies were originally issued in the form of non-cumulative preferred stock to preserve the Tier 1 treatment for such institutions.)  Current estimates are that there is approximately $129 billion in Tier 1 capital that would be eliminated by the disqualification of trust preferred securities as Tier 1 capital, which could force a corresponding $1.3 trillion deleveraging of bank balance sheets, and would cause an average decline of over 200 basis points in the capital ratios of publicly owned bank holding companies. (As background, the FDIC has always objected to the Federal Reserve’s determination, starting in 1996, that trust preferred securities should be included as Tier 1 capital.)

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