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Wow! The Fed responds to comments from Community Banks on Basel III

While the final Basel III capital rules have not been published at the time of this post, it was clear from this morning’s comments at the meeting of the Board of Governors of the Federal Reserve System that community banks have been heard. Highlights from the meeting include the following positions of the Federal Reserve on the Basel III rules.

  •  AOCI – Non-internationally active financial institutions (i.e., all community banks) will be allowed a one-time option to opt out of the inclusion of accumulated other comprehensive income in Tier 1 regulatory capital. This opt-out option will ease the potential burden on community banks from incorporating fluctuations in the value of their available for sale securities portfolio in their regulatory capital calculations. We view this as a big win for community banks.
  • Mortgage Loan Risk-Weighting – Many community banks expressed a great deal of concern with the proposed risk weighting of residential mortgage loans, which was based on loan-to-value ratios and certain other features, including whether or not the loan had a balloon feature. In response to those comments, the final Basel III rule will contain no changes to the current risk weighting of residential mortgage loans. While this is a nice win for banks and borrowers, the separate qualified mortgage rules will likely impact mortgage lending in the future.
  • Trust Preferred Securities – The final Basel III rules will grandfather the eligibility of trust preferred securities to qualify as Tier 1 capital for bank holding companies with less than $15 billion in total consolidated assets. This change will obviate the need for many community banks to raise capital through the issuance of common equity to replace the Tier 1 capital previously provided by the issuance of trust preferred securities.

While the written rule will undoubtedly contain a great deal of additional clarifications, the early comments from the meeting of the Board of Governors of the Federal Reserve System indicate that the rally of community banks against certain aspects of the Basel III rules was very successful. We will publish more analysis as we digest the final rules.

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Bryan Cave Lawyers Briefing State Banking Associations on Basel III Proposals

In recent weeks, three Bryan Cave lawyers have briefed state banking association members on the impact the Notices of Proposed Rule Making regarding Basel III could have on banks of all sizes. On July 12, Jonathan Hightower presented via webinar to the Georgia Bankers Association. On August 16, Jonathan Hightower and B.T. Atkinson participated in a live seminar on Basel III presented by the South Carolina Bankers Association that also included presentations by Garry Rank of Elliott Davis, LLP and Jim Mabry of Keefe, Bruyette & Woods. The SCBA program also included a segment advising institutions on how to prepare a comment letter on the proposals for submission to their primary federal banking agency. On August 20, Michael Shumaker and B.T. Atkinson presented via webinar to the North Carolina Bankers Association. In all three programs, bankers were strongly encouraged to submit comments on the proposals by the October 22 deadline, citing specific examples of how the proposed rules could negatively impact their bank. Areas noted for potential comment included:

  • phase-out of trust preferred from Tier 1 capital for institutions having less than $15 billion in assets; 
  • appropriateness of the capital conservation buffer for banking organizations that are not systemically significant; 
  • inclusion of unrealized gains and losses on securities in common equity Tier 1 capital; 
  • whether the exclusion for bank holding companies having total assets of $500 million or less should be increased to $1 billion and include savings and loan holding companies; and 
  • the impact of the proposed risk-weighting of first and second lien mortgages on product availability and the anticipated burdens of implementation.

Links to related Financial Institution Letters:

FIL-25-2012:  Regulatory Capital Rules:  Regulatory Capital, implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, and Transition Provisions

FIL-27-2012:  Regulatory Capital Rules:  Standardized Approach for Risk-Weighted Assets; Market Discipline and Disclosure Requirements

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First Banks, Inc. Announces Successful Trust Preferred Consent Solicitation

In its earnings release issued on January 28, 2011, First Banks, Inc. (the “Company”) announced the successful completion of its consent solicitation addressed to the holders of the trust preferred securities issued by First Preferred Capital Trust IV (the “Trust”). The securities are listed on The New York Stock Exchange under the symbol “FBSPrA.” As a result of the consent solicitation, the Company was able to effect amendments to the related indenture, trust agreement and guarantee agreement that are designed to provide additional capital planning flexibility for the Company.

The amendments relate primarily to covenants restricting the Company’s activities during a period in which interest and dividend payments have been deferred in accordance with the terms of the securities. They provide an “exchange exception” to covenants against the Company’s or its subsidiaries’ acquisition of their capital stock during a deferral period, which the Company entered in September 2009. As a result of the amendments, the Company and its subsidiaries and affiliates may issue capital stock during a deferral period in exchange for or upon conversion of outstanding Company, subsidiary or affiliate capital stock or for outstanding Company indebtedness ranking pari passu with or junior to the debentures. The amendments also eliminate a covenant against the Company’s acquisition of any of the trust preferred securities issued by the Trust or less than all of the related debentures during deferral. These and other amendments are attached as exhibits to the Company’s Current Report on Form 8-K filed with the SEC on January 27, 2011 .

In the earnings release, the Company reported that the success of the consent solicitation better positions the Company to consider certain potential capital planning strategies to improve the its regulatory capital ratios and further strengthen its overall financial position.

Bryan Cave represented First Banks in the consent solicitation and has significant experience in dealing with trust preferred securities.

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Financial Services Update

Financial Services Update

August 20, 2010

Authored by: Matt Jessee

Department of Labor Weekly Unemployment Report Released 

On Friday, the Department of Labor announced that the unemployment rate fell in 18 states during the month of July. The Department also said the jobless rate rose in 14 states and stayed the same in the remaining 18 states. Nationwide, the unemployment rate remained stuck at 9.5 percent in July. New York and Massachusetts reported strong job gains with Massachusetts reporting that it added 19,200 private-sector jobs in July, the largest monthly gain for any state in more than 20 years. 

Housing Conference Foreshadows Fight Ahead 

On Tuesday, the Departments of Treasury and HUD invited a cross section of housing and banking industry participants to Washington for a summit on the future of the housing finance industry. The industry representatives voiced overwhelming support for the government to maintain a large role in supporting the nearly $11 trillion mortgage market. Participants expressed support for a new program that would allow homeowners to refinance their mortgages at lower interest rates through Fannie Mae and Freddie Mac, although Treasury officials indicated they have no plans to enact such a program.

 Treasury Secretary Timothy Geithner pledged “fundamental change” to the structure of Fannie and Freddie, but saying that the two companies were not the only cause of the financial crisis. While Geithner did not offer a specific strategy for reforming the two mortgage giants, he said that the government could remain involved in the mortgage system by guaranteeing that investors in mortgage-backed securities receive fair compensation, even when borrowers default. Representative Spencer Bachus (R-AL), the Ranking Republican on the House Financial Services Committee, accused the Administration of excluding critics of the Administration from Tuesday’s conference. In a letter to Secretary Geithner, Bachus said the housing conference appears to be “laying the groundwork for a predetermined policy outcome that looks uncomfortably similar to the failed status quo.” 
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Capital Treatment of Trust Preferred Securities and TARP CPP Preferred Stock

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.

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Financial Services Update – Issue 23

Financial Regulatory Reform Bill

The House and Senate conference committee on the Wall Street Reform Act met formally for the first votes on Tuesday and concluded for the week on Thursday. On Tuesday, conferees agreed to increase permanently the deposit insurance limit to $250,000 and retroactively cover the period between Jan. 1, 2008 and October 3, 2008, when the limit was first temporarily raised to $250,000. The retroactive change means that depositors with between $100,000 and $250,000 affected by 16 bank failures during the time frame will be entitled to some recovery. The conferees also agreed to eliminate the 1.50% hard cap on the Deposit Insurance Fund and give the FDIC full discretion to decide whether to rebate any excess over that amount. The provision also eliminates the automatic “brake” on the growth of the fund which required partial dividends after the reserve ratio exceeded 1.35 percent. However, conferees could not come to agreement on the Transaction Account Guarantee program. The House conferees proposed making the program permanent for all banks, while the Senate’s representatives would agree only to a two-year extension beyond the current Dec. 31, 2010 expiration date. House Financial Services Committee Chairman Barney Frank (D-MA) said the House would consult with the Congressional Budget Office to determine if making the program permanent would generate significant government cost savings. The conferees also agreed to grandfather mutual holding companies’ dividend waiver policies in place as of Dec. 1, 2009. Senate conferees, however rejected a House offer to establish a mutual national bank charter.

On Wednesday, the conference committee voted to permanently exempt companies with less than $75 million in market capitalization from compliance with the Sarbanes-Oxley Act’s Section 404(b) auditor attestation requirements. Conferees also agreed to remove Rep. Maxine Waters’ (D-CA) provision that would have enhanced investors’ ability to bring lawsuits against those who knowingly or unknowingly provided “substantial assistance” to primary violators in securities fraud.

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Updated Thoughts on Treatment of Trust Preferred under the Financial Reform Bill

Last week the conference committee charged with reconciling the House and Senate versions of the federal financial reform bill began its formal deliberations, and this debate continues in open session.  The language originally proposed by Sen. Susan Collins (R-Maine) remains in the base text  on which reconciliation efforts will focus.  The Collins amendment would exclude trust preferred from the consolidated Tier 1 capital of banks and holding companies.  This would force an estimated $1.3 trillion in deleveraging and would affect the roughly 600 banks with less than $10 billion in assets that hold these securities as Tier 1 capital.  Here we provide an update on this aspect of the reform bill and its likely fate between now and the conference committee’s self-imposed July 4 reconciliation deadline.

Observers consistently note that FDIC has been the driving force behind this amendment and that it will continue to advocate for it.  Collins being a Republican, Democrats are not likely to dismiss her proposal out of hand during the reconciliation process—the reconciled bill will still need to garner a 60-vote supermajority to proceed to a final passage vote on the Senate floor.  As you may recall, the May 20 passage vote on the Senate bill (59-39 in favor) followed the narrowest of victories in the vote to end debate on it:   60-40.  In that vote, Collins joined just two other Republican Senators, including fellow Maine senator Olympia Snowe, and two independents in voting with Democrats for cloture.  Those five votes offset negative votes on the matter by two Democrats in an otherwise partisan passage vote.

Their possible influence notwithstanding, since the Senate’s May 20th vote on the bill, both Collins and the FDIC have expressed a willingness to soften the implementation of her proposal:

  • Collins, in a June 7 interview:  “I’m taking a look at all of these suggestions.  I will say that it’s clear to me from talking to the FDIC chairman that trust-preferred is a debt instrument and cannot easily be converted into common equity, and therefore I don’t think it should qualify as Tier 1 capital. Having said that, I recognize that there is a need for a transition period, and that’s what we are taking a look at.”
  • FDIC spokesman Andrew Gray on June 8:  “With respect to the Collins amendment, the FDIC supports grandfathering or providing a transition period for TruPS.  We’ve publicly acknowledged the need for special transition rules.”
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Will Trust Preferred Retain Tier 1 Capital Status?

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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Reminder Regarding Inclusion of Trust Preferred Securities in Tier 1 Capital

Although the trust preferred securities (“TPS”) market has been quiet (or non-existent) for the past few years, many bank holding companies have issued TPS in the past to take advantage of the hybrid capital treatment afforded to TPS by the Federal Reserve.  In 2005, the Federal Reserve revised its rules permitting the inclusion of a limited amount of TPS in the Tier 1 capital to provide stricter quantitative limits. Under the 2005 rule, which became effective on March 31, 2009, bank holding companies may include TPS in Tier 1 capital in an amount up to 25% of all core capital elements less goodwill and any associated deferred tax liability. Core capital elements include common shareholders’ equity, noncumulative perpetual preferred stock (including preferred stock issued pursuant to the Troubled Asset Relief Program (TARP)), and minority interests directly issued by a consolidated U.S. depository institution or foreign bank subsidiary. Any TPS issued in excess of this limit may be included in Tier 2 capital.

Prior to March 31, 2009, bank holding companies were permitted to calculate the limit for TPS without deducting goodwill and associated deferred tax liability from Tier 1 capital. The regulators are now taking note that some bank holding companies with outstanding TPS have not revised their Tier 1 calculations to comply with the newly-effective rule. If your bank has a holding company with outstanding TPS, be sure that you are limiting the TPS component of Tier 1 capital to 25% of core capital elements less goodwill and any associated deferred tax liability.

In addition, in the current economic environment, many bank holding companies are experiencing deterioration in capital. When the core capital elements of Tier 1 capital decline, the amount of TPS that may be included in Tier 1 capital also declines, thereby further reducing a bank holding company’s leverage ratio. When calculating capital ratios, bank holding companies must remember to re-evaluate the inclusion of TPS in Tier 1 capital as capital declines.

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