[Federal Register: May 19, 2004 (Volume 69, Number 97)]
[Proposed Rules]
[Page 28851-28860]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr19my04-14]
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FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-1193]
Risk-Based Capital Standards: Trust Preferred Securities and the
Definition of Capital
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Board of Governors of the Federal Reserve System (Board)
proposes to allow the continued inclusion of outstanding and
prospective issuances of trust preferred securities in the tier 1
capital of bank holding companies, subject to stricter quantitative
limits and qualitative standards. The Board also proposes to revise the
quantitative limits applied to the aggregate amount of cumulative
perpetual preferred stock, trust preferred securities, and minority
interests in the equity accounts of certain consolidated subsidiaries
(collectively, restricted core capital elements) included in the tier 1
capital of bank holding companies. The quantitative limits would become
effective after a three-year transition period. In addition, the Board
is proposing to revise the qualitative standards for capital
instruments included in regulatory capital consistent with longstanding
Board policies. These revisions are being proposed to address
supervisory concerns, competitive equity considerations, and changes in
generally accepted accounting principles. The proposal would have the
effect of strengthening the definition of regulatory capital for bank
holding companies.
DATES: Comments must be received by no later than July 11, 2004.
ADDRESSES: You may submit comments, identified by Docket No. R-1193, by
any of the following methods:
Agency Web Site: http://www.federalreserve.gov Follow the instructions for submitting comments at http://www.federalreserve.gov/.
.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: regs.comments@federalreserve.gov. Include docket
number in the subject line of the message.
FAX: 202/452-3819 or 202/452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue,
NW., Washington, DC 20551.
All public comments are available from the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, except as necessary for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
information. Public comments may also be viewed electronically or in
paper form in Room MP-500 of the Board's Martin Building (20th and C
Streets, NW.) between 9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Norah Barger, Associate Director (202/
452-2402 or norah.barger@frb.gov), Mary Frances Monroe, Manager (202/
452-5231 or mary.f.monroe@frb.gov), John F. Connolly, Senior
Supervisory Financial Analyst (202/452-3621 or
john.f.connolly@frb.gov), Division of Banking Supervision and
Regulation, or Mark E. Van Der Weide, Senior Counsel (202/452-2263 or
mark.vanderweide@frb.gov), Legal Division. For users of
Telecommunications Device for the Deaf (``TDD'') only, contact 202/263-
4869.
SUPPLEMENTARY INFORMATION:
Background
The Board's current risk-based capital guidelines, which are based
on the 1988
[[Page 28852]]
Basel Accord, as well as the Board's leverage capital guidelines for
bank holding companies (BHCs), allow BHCs to include in their tier 1
capital the following items that are defined as core (or tier 1)
capital elements: common stockholders' equity; qualifying noncumulative
perpetual preferred stock (including related surplus); qualifying
cumulative perpetual preferred stock (including related surplus); and
minority interest in the equity accounts of consolidated subsidiaries.
Qualifying cumulative preferred stock is limited to 25 percent of the
sum of core capital elements. Tier 1 capital generally is defined as
the sum of core capital elements less any amounts of goodwill, other
intangible assets, interest-only strips receivable, deferred tax
assets, non-financial equity investments, and other items that are
required to be deducted from a BHC's tier 1 capital for purposes of
calculating regulatory capital ratios.
The Federal Reserve's capital guidelines allow minority interest in
the equity accounts of consolidated subsidiaries to be included in a
BHC's tier 1 capital because it represents capital support from third-
party investors in a subsidiary owned by a BHC and consolidated on its
balance sheet. Nonetheless, minority interest does not constitute
equity on the BHC's consolidated balance sheet because typically
minority interest is available to absorb losses only within the
subsidiary that issues it and is not generally available to absorb
losses in the broader consolidated banking organization. Although the
Board's capital rules state that voting common stock generally should
be the dominant form of tier 1 capital, minority interest is not
subject to a specific numeric limit. Minority interest in the form of
cumulative preferred stock, however, generally has been subject to the
same limits as cumulative preferred stock issued directly by a BHC.
In 1996, the Board explicitly approved the inclusion in BHCs' tier
1 capital of minority interest in the form of trust preferred
securities. Trust preferred securities are undated cumulative preferred
securities issued out of a special purpose entity (SPE), usually in the
form of a trust, in which a BHC owns all of the common securities. The
trust preferred securities allow for at least twenty consecutive
quarters of dividend deferral, after which the investors have the right
to take hold of the sole asset in the trust, a deeply subordinated note
issued by the BHC. The note, which is subordinated to all obligations
of the BHC other than its common and preferred stock, has terms that
generally mirror those of the trust preferred securities, except that
the subordinated debt has a fixed maturity of at least 30 years. Trust
preferred securities are considered tax-efficient because, for tax
purposes, payments on the instrument are deductible from the issuer's
income, unlike dividends on directly issued preferred stock, which must
be paid from after-tax earnings. Because trust preferred securities are
cumulative, they currently are limited, together with directly issued
cumulative perpetual preferred stock and other minority interest in the
form of cumulative preferred stock, to no more than 25 percent of a
BHC's core capital elements.
The Board's decision to include trust preferred securities in tier
1 capital was based on a number of factors in addition to its
qualification as minority interest under generally accepted accounting
principles (GAAP). In terms of features, trust preferred securities
have long lives that approach economic perpetuity and deferral rights
that, at twenty consecutive quarters, approach economically indefinite
deferral. With regard to loss absorbency, trust preferred securities,
like other minority interest included in tier 1 capital, cannot deter
technical insolvency because they are not represented as equity on the
BHC's consolidated balance sheet. Unlike minority interest in the form
of equity in a typical operating subsidiary, however, trust preferred
securities are available to absorb losses more broadly in the
consolidated banking organization. Its availability for this purpose
stems from the fact that the sole asset of the issuing subsidiary is a
note from the parent BHC, which constitutes a deeply subordinated claim
on the consolidated BHC. Thus, if a BHC defers payments on trust
preferred securities, the cash flow preserved can be used anywhere
within the consolidated organization. Dividend deferrals on equity in
the typical operating subsidiary, on the other hand, absorb losses and
preserve cash flow only within the subsidiary; the cash that is freed
up cannot be used elsewhere in the consolidated organization.
The Board also considered competitive equity factors in making its
decision to include trust preferred securities in tier 1 capital. A
number of non-BHC companies, including domestic and non-domestic
financial institutions, had issued trust preferred securities or
similar tax-efficient instruments. Thus, these companies were able to
enjoy a lower after-tax cost of capital than BHCs that compete in some
of the same markets. Since 1996, approximately 820 BHCs have issued
over $77 billion of trust preferred securities, the popularity of which
stems in large part from its tax-efficiency.
Trust preferred securities are not the only tax-efficient source of
tier 1 capital, although BHCs tend to favor them because they are
relatively simple, standard, and well-understood instruments that are
also issued by non-banking corporations. One alternative tax-efficient
instrument that is included in the tier 1 capital of banks and BHCs as
minority interest in the form of perpetual preferred securities is
referred to as real estate investment trust (REIT) preferred
securities. These securities, which usually are noncumulative, are
issued by an SPE that qualifies as a REIT for tax purposes. Proceeds
from the issuance of the REIT's common securities, which are wholly
owned by the sponsoring banking organization, and preferred securities,
which are owned by third-party investors, are used to buy real estate-
related assets. Because the source of the assets typically is a
subsidiary bank of the sponsoring banking organization, REIT preferred
securities are usually issued by an SPE that is a subsidiary of the
bank, rather than of the BHC. Statutorily, dividends on REIT preferred
securities may be deducted from the taxable income of the banking
organization if the assets are related to real estate and certain other
criteria are met, including the distribution of 95 percent of the
REIT's income in dividends to investors. A key prudential condition for
REIT preferred securities to be included in tier 1 capital is that they
must have an exchange feature providing for an exchange of the
securities for an equal amount of directly-issued perpetual preferred
securities of the sponsoring bank with identical terms upon the
occurrence of certain events, including the event that the sponsoring
bank becomes undercapitalized or insolvent. This feature is necessary
for regulatory capital inclusion of the REIT preferred securities
because they are effectively secured by the assets of the SPE, which
often are high quality and very liquid. The Federal Reserve, together
with the other Federal banking agencies, limits the inclusion of REIT
preferred securities to 25 percent of the sum of a banking
organization's core capital elements.
A few banking organizations have used other asset-driven structures
that are similar to REIT preferred securities to issue tier 1 preferred
securities that are included in minority interest and are subject to
the same exchange provision as REIT preferred securities. Asset-
[[Page 28853]]
driven structures can be highly tailored to suit investors' needs and
the preferred securities issued out of them are often privately placed.
However, the amount of preferred securities issued out of REITs and
similar asset-driven structures is relatively small. BHCs generally
favor issuing trust preferred securities instead of preferred
securities issued out of asset-driven structures because trust
preferred securities do not tie up liquid assets, are easier and more
cost-efficient to issue and manage, and are more transparent and better
understood by the market. Also, banking organizations generally prefer
to issue non-asset-backed preferred securities at the holding company
level to give them maximum flexibility in the use of the proceeds of
such issuances, a flexibility that is not available for asset-backed
instruments issued at the bank level. From a supervisory perspective,
asset-driven structures raise concerns because they trap high quality,
liquid assets in a subsidiary that the banking organization would have
difficulty accessing to meet immediate liquidity needs.
Factors in the Reconsideration of the Treatment of Trust Preferred
Securities
Overall, the supervisory experience with trust preferred securities
has been positive. The instrument has performed much as expected in
troubled banking organizations; in numerous instances, BHCs in
deteriorating financial condition have deferred dividends on trust
preferred securities to preserve cash flow. In addition, trust
preferred securities have proven to be a useful source of capital
funding for BHCs, which often downstream the proceeds in the form of
common stock to subsidiary banks, thereby strengthening the banks'
capital bases. For example, in the months following the events of
September 11, 2001, a period when issuance of most other capital
instruments was extremely difficult, BHCs were able to execute large
issuances of trust preferred securities to retail investors,
demonstrating the financial flexibility offered by this instrument.
Around 2000, the first securities backed by a pool of trust
preferred securities from multiple issuers came to the market. Pooling
arrangements, which have become increasingly popular and typically
involve thirty or so separate issuers, have made the issuance of trust
preferred securities possible for even very small BHCs, most of which
had not previously enjoyed capital market access for tier 1
instruments. Although this development has helped level the competitive
playing field between small and large banking organizations with regard
to capital funding sources, it also has given rise to concerns.
Evidence supports the view that, in some instances, BHCs that
participate in poolings have over-relied on trust preferred securities
within their capital structures. As a result, for some time the Federal
Reserve has been considering ways to limit undue reliance on these
instruments.
Excessive reliance generally has not been a concern at large
banking organizations because they are subject to much more rigorous
market discipline, which works to limit the amount of trust preferred
securities a BHC may issue. Moreover, a 1998 agreement among the G-10
banking supervisors that participate in deliberations of the Basel
Committee on Banking Supervision called for the Federal Reserve's best
efforts to limit the issuance by internationally active banking
organizations of innovative instruments'a category that would include
trust preferred securities'to 15 percent of their tier 1 capital.
Although the Federal Reserve has informally encouraged BHCs to comply
with this standard, the Federal Reserve's commitment to the standard
has not been formalized.
As the Federal Reserve was working through various issues related
to trust preferred securities and alternative tax-efficient
instruments, the accounting treatment of trust preferred securities was
revised, adding yet another factor to be taken into account in the
reconsideration of the regulatory capital treatment of these
instruments. In January 2003, the Financial Accounting Standards Board
(FASB) issued Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46). Since then the accounting industry and BHCs have
wrestled with the application of FIN 46 to the consolidation by BHC
sponsors of trusts issuing trust preferred securities. In late December
2003, when FASB issued a revised version of FIN 46 (FIN 46R), the
accounting authorities generally concluded that such trusts must be
deconsolidated in financial statements under GAAP. The result is that,
under GAAP, trust preferred securities generally continue to be
accounted for as equity at the level of the trust that issues them, but
the instruments may no longer be treated as minority interest in the
equity accounts of a consolidated subsidiary on a BHC's consolidated
balance sheet. Instead, upon adopting FIN 46 and FIN 46R, a BHC no
longer may reflect on its balance sheet the trust preferred securities
issued out of the SPE, but rather must reflect the deeply subordinated
note the BHC issued to the deconsolidated SPE.
Consistent with longstanding Board direction, BHCs are required to
follow GAAP for regulatory reporting purposes. Thus, BHCs should, for
both accounting and regulatory reporting purposes, determine the
appropriate application of GAAP (including FIN 46 and FIN 46R) to their
trusts issuing trust preferred securities. Accordingly, there should be
no substantive difference in the treatment of such trusts for purposes
of regulatory reporting and GAAP accounting.
The change in the GAAP accounting of a capital instrument does not
necessarily change the regulatory capital treatment of that instrument.
Although GAAP informs the definition of regulatory capital, the Federal
Reserve is not bound by GAAP accounting in its definition of tier 1 or
tier 2 capital because these are regulatory constructs designed to
ensure the safety and soundness of banking organizations, not
accounting designations designed to ensure the transparency of
financial statements. The current definition of tier 1 capital differs
from GAAP equity in a number of ways that the Federal Reserve has
determined are consistent with its responsibility for ensuring the
soundness of the capital bases of banking organizations under its
supervision. These differences do not constitute differences between
regulatory reporting and GAAP accounting requirements, but rather are
differences only between GAAP equity and the concept of tier 1 capital
as used in the Board's regulatory capital requirements for banking
organizations.
Proposed Regulatory Capital Treatment of Trust Preferred Securities
In proposing a revised capital treatment of trust preferred
securities, the Board has taken into account a number of factors. In
addition to its supervisory experience and the revised accounting
treatment, the Board has considered domestic and international
competitive equity issues and supervisory concerns with alternative
tax-efficient instruments. In balancing all these considerations, the
Board has decided to propose permitting BHCs to continue to include
outstanding and prospective issuances of trust preferred securities in
their tier 1 capital, subject to stricter quantitative limits, which
would apply to a broader range of capital instruments issued by BHCs.
In the Board's view, experience with trust preferred securities has
demonstrated that they can play a useful role in providing financial
support to banking organizations in deteriorating
[[Page 28854]]
financial condition. Although the consolidated accounting treatment for
trust preferred securities, which continue to be accounted for as
equity at the issuing entity level, has been revised, neither the
instrument nor any of its features have changed since 1996 when the
Board decided that the securities could be included in tier 1 capital.
From a competitive equity point of view, poolings of trust preferred
securities have permitted small BHCs for the first time to access the
capital markets for tier 1 capital, which larger BHCs have long
enjoyed. No alternative tier 1 structure to trust preferred securities
has emerged that can be similarly pooled and issued to the capital
markets by small banking organizations. With regard to large BHCs, the
Board is aware that their foreign competitors have issued as much as
$125 billion of similar tax-efficient tier 1 capital instruments and
that preventing the use of a standard tax-efficient capital instrument
by U.S. BHCs could place them at a competitive disadvantage.
In reviewing existing alternative tax-efficient tier 1 capital
instruments available to BHCs, the Board has concluded that in several
ways trust preferred securities are a superior instrument to these
alternatives. In this regard, trust preferred securities are available
to absorb losses throughout the BHC and do not affect the BHC's
liquidity position. Trust preferred securities are relatively simple,
standardized, and well-understood instruments that are widely issued by
both corporate and banking organizations. Moreover, issuance of trust
preferred securities tends to be broad and transparent and, thus, easy
for the market to track. In the Board's view, these reasons support
maintaining trust preferred securities as a component of tier 1 capital
within limits that should likewise be applied to other capital
instruments that do not provide the same level of capital support as
common equity and noncumulative perpetual preferred stock.
Accordingly, in formulating quantitative limits for trust preferred
securities, the Board has decided to apply them to a range of other
instruments. Since 1989, cumulative perpetual preferred stock has been
limited to 25 percent of the sum of core capital elements. In 1996,
trust preferred was grouped together with other cumulative preferred
stock for the purpose of the 25 percent limit. The Board is proposing
to continue subjecting cumulative perpetual preferred stock and trust
preferred securities to a common limit, while requiring other capital
elements in the form of minority interest in the equity accounts of
consolidated subsidiaries to be subject to that same limit. In this
regard, the Board is proposing to distinguish among three types of
qualifying minority interest. The aim of making this distinction is to
allow common and preferred equity instruments issued directly by a
consolidated U.S. depository institution or foreign bank subsidiary of
a BHC to receive a treatment parallel to similar instruments issued
directly by a BHC, while placing additional restrictions on minority
interest in the equity accounts of other subsidiaries, whether the
subsidiary is at the bank or the BHC level.
Thus, the Board is proposing that minority interest related to
qualifying common or noncumulative perpetual preferred stock directly
issued by a consolidated U.S. depository institution or foreign bank
subsidiary (Class A minority interest) would not be subject to formal
limitation within tier 1 capital. Under the proposal, minority interest
related to qualifying cumulative perpetual preferred stock directly
issued by a consolidated U.S. depository institution or foreign bank
subsidiary (Class B minority interest) would be a restricted core
capital element subject to limitation within tier 1 capital, but not
subject to a tier 2 capital sublimit. Finally, minority interest in the
form of qualifying common stockholders' equity or qualifying perpetual
preferred stock (and related surplus) in a consolidated subsidiary that
is neither a U.S. depository institution nor a foreign bank (Class C
minority interest) would be eligible for inclusion in tier 1 capital as
a restricted core capital element. In addition, as discussed below,
Class C minority interest, which would include REIT preferred
securities and other asset-driven capital instruments whether issued
directly by a nonbank subsidiary of the BHC or of a U.S. depository
institution or foreign bank subsidiary of the BHC, is subject to a tier
2 sublimit.
As discussed above, minority interest in a typical operating
subsidiary does not stave off technical insolvency or provide capital
support for the broader consolidated organization. Minority interest in
the equity accounts of a consolidated U.S. depository institution or
foreign bank subsidiary, however, does absorb losses throughout the
issuing U.S. depository institution or foreign bank and provides
protection to depositors, whose deposit accounts are often government-
insured. Further, a BHC generally is expected to support a subsidiary
depository institution. Because of the special role that such minority
interest plays in protecting subsidiary depository institutions, the
Board is proposing a more favorable treatment for Class A and Class B
minority interest within tier 1 capital than it is proposing for
minority interest in the equity accounts of other consolidated
subsidiaries, including subsidiaries of a consolidated U.S. depository
institution or foreign bank subsidiary or a subsidiary of the parent
BHC (Class C minority interest). The Board seeks views on the
appropriateness of the distinction among types of minority interest and
specifically seeks comment on the treatment of minority interest in a
foreign bank subsidiary of a BHC.
The limit the Board is proposing for the aggregate amount of a
BHC's cumulative perpetual preferred stock, trust preferred securities,
Class B minority interest, and Class C minority interest (collectively
referred to as restricted core capital elements) is 25 percent of core
capital elements, net of goodwill. By netting goodwill from the
calculation of the 25 percent limit, the Board is tightening the
current 25 percent limit, which currently is determined on a basis that
does not deduct goodwill. Deducting goodwill from core capital elements
will help ensure that a BHC is not unduly leveraging its tangible
equity to issue restricted core capital elements. The deduction of
goodwill for the purpose of this limit is also consistent with the
direction taken by the Basel Committee on Banking Supervision in its
consultative paper on a new capital accord. The paper proposes that
limits set for so-called innovative capital instruments within tier 1
capital be determined on a basis that deducts goodwill from the sum of
core capital elements.
Qualifying cumulative perpetual preferred stock and Class B
minority interest in excess of the 25 percent limit would be includable
in tier 2 capital with no sublimit. To further guard against potential
over-reliance on trust preferred securities and other non-equity
elements within a BHC's capital structure, the Board is proposing that
amounts of qualifying trust preferred securities and Class C minority
interest in excess of the 25 percent limit be included in tier 2
capital but be limited, together with subordinated debt and limited-
life preferred stock, to 50 percent of tier 1 capital. A BHC would be
free to attribute its excess amounts of restricted core capital
elements first to any qualifying cumulative perpetual preferred stock
or to Class B minority interest, and second to qualifying trust
[[Page 28855]]
preferred securities or Class C minority interest, which are subject to
the tier 2 sublimit.
To help ensure comparability in capital structures among
internationally active banking organizations, the Board is proposing to
amend its capital guidelines to make explicit the Board's general
expectation that internationally active BHCs limit the amount of
restricted core capital elements to 15 percent of the sum of core
capital elements, including restricted core capital elements, net of
goodwill. The 15 percent limit for internationally active banking
organizations is in line with the above-mentioned 1998 Basel agreement
concerning innovative capital instruments. As indicated above, most
internationally active banking organizations have long used the 15
percent limit as a guideline for their issuance of innovative
instruments. For this purpose, an internationally active BHC is one
that has significant activity in non-U.S. markets or that is considered
a candidate for the Advanced Internal Ratings Based Approach under the
proposals for a new Basel Accord. The Board seeks comment on whether
the capital guidelines for BHCs should contain such an explicit
expression of the Board's expectation for internationally active BHCs
with respect to use of restricted core capital elements, should impose
an explicit 15 percent limit on the use by internationally active BHCs
of restricted core capital elements, or should include a more explicit
definition of internationally active BHCs.
The proposal would provide a three-year transition period for BHCs
to meet the new, stricter limitations within regulatory capital by
proposing that the limits on restricted core capital elements become
fully effective as of March 31, 2007. During the interim, BHCs with
restricted core capital elements in excess of these limits must consult
with the Federal Reserve on a plan for ensuring that the banking
organization is not unduly relying upon these elements in its capital
base and, where appropriate, for reducing such reliance. Until March
31, 2007, BHCs generally must comply with the current tier 1 capital
limits. That is, BHCs generally should calculate their tier 1 capital
on a basis that limits the aggregate amount of qualifying cumulative
perpetual preferred stock and qualifying trust preferred securities to
25 percent of the sum of qualifying common stockholders' equity,
qualifying noncumulative and cumulative perpetual preferred stock
(including related surplus), qualifying minority interest in the equity
accounts of consolidated subsidiaries, and qualifying trust preferred
securities. Amounts of qualifying cumulative perpetual preferred stock
and qualifying trust preferred securities in excess of this limit may
be included in tier 2 capital.
The Board is also proposing to revise the capital guidelines to
specify the criteria trust preferred securities must meet to be
eligible for inclusion in tier 1 capital. Under these criteria, which
the Board has broadly used since 1996, a BHC must consult with the
Federal Reserve before issuing trust preferred securities. Such
consultation would normally be undertaken with the BHC's District
Reserve Bank. Qualifying trust preferred securities must be undated and
provide for a minimum of twenty consecutive quarters of dividend
deferral, as well as a call at the BHC's option commencing no later
than ten years from issuance. The Board seeks comment on the continued
requirement for a call option on trust preferred securities qualifying
for inclusion in tier 1 capital. The criteria also specify that the
sole asset of the trust must be a subordinated note issued by the BHC,
which must have a minimum maturity of thirty years and must be
subordinated to all other subordinated debt of the BHC. The terms of
the subordinated note must conform to the requirements of the Board's
subordinated debt policy statement, 12 CFR 250.166, although,
consistent with the approved structure of these securities, the note
may become due and payable upon default following the deferral of
dividends for more than 20 consecutive quarters. Trust preferred
securities issued before May 31, 2004 for which the underlying
subordinated debt does not comply with 12 CFR 250.166 may continue to
be included in tier 1 capital provided the noncomplying terms (i) have
been commonly used by banking organizations, (ii) do not provide an
unreasonably high degree of protection to the holder in circumstances
other than bankruptcy, and (iii) do not effectively allow the holder in
due course of the note to stand ahead of senior or subordinated debt
holders in the event of bankruptcy. With regard to trust preferred
securities issued by a BHC to a pool, the proposal sets forth the
longstanding Board policy that the BHC may not purchase a security
issued by that same pool. Where it does hold such a security (for
example, through an acquisition of another banking organization), the
notional amount of that security must be deducted from the amount of
trust preferred securities qualifying for inclusion in regulatory
capital.
The proposal also provides that in the last five years before the
underlying subordinated note matures, the associated trust preferred
securities must be treated as limited-life preferred stock. Thus, in
the last five years of the life of the note, the outstanding amount of
trust preferred securities will be excluded from tier 1 capital and
included in tier 2 capital, subject, together with subordinated debt
and other limited-life preferred stock, to a limit of 50 percent of
tier 1 capital. During this period, the trust preferred securities will
be amortized out of tier 2 capital by one-fifth of the original amount
(less redemptions) each year and excluded totally from tier 2 capital
during the last year of life of the underlying note.
Other Proposed Revisions
To ensure that the overall framework for the definition of
regulatory capital remains effective, the Board is proposing a number
of revisions to set forth in the capital guidelines for BHCs
longstanding policies with regard to the terms and features of
qualifying capital instruments. The Board seeks comment on whether
parallel revisions to the definition of regulatory capital for state
member banks should be made in Regulation H.
The proposal notes that where a BHC has directly or indirectly
funded the purchase of an instrument, the instrument generally is
excluded from regulatory capital. This provision is not intended to
capture unintentional, indirect funding of capital instruments but
rather intentional arrangements that undermine the concept that
instruments included in regulatory capital must be fully paid up. The
proposal also clarifies that common stockholders' equity may not have
terms or features that create investor preferences, and strengthens
language on the need for voting common equity to be the dominant form
of tier 1 capital. In addition, the proposal emphasizes the need for a
BHC to have the unrestricted ability to waive preferred dividends and
the general expectation of the Board that such dividends will be waived
when a BHC is in weakened condition and clarifies the distinction
between cumulative and noncumulative preferred stock. The proposal also
sets forth the general exclusion from tier 1 capital of preferred
instruments with dividend rate step-ups or so-called market value
conversion features whereby the holder must or can convert the
preferred instrument into common stock at the market price prevailing
at the time of the conversion.
[[Page 28856]]
Such features tend to either increase an organization's cost of capital
or provide powerful incentives for an organization to redeem capital at
a time when its condition is deteriorating, lessening the extent to
which the instrument can help a BHC weather a period of distress.
Further, the proposal incorporates into the guidelines for subordinated
debt a reference to the Federal Reserve's subordinated debt policy
statement set forth in 12 CFR 250.166, which outlines a number of
technical requirements that subordinated debt included in regulatory
capital must meet. The proposal also incorporates some clarifications
of that policy with regard to subordination and acceleration. The Board
seeks comment on whether similar clarifying amendments, or any other
amendments, should be made to the subordinated debt policy statement.
The Board also is considering clarifying either by rulemaking or
through supervisory guidance the treatment of qualifying trust
preferred securities issued by small BHCs (that is, BHCs with
consolidated assets of $150 million or less) under the Small Bank
Holding Company Policy Statement, 12 CFR Part 225 Appendix C (Small BHC
Policy Statement), which generally exempts small BHCs from the Board's
risk-based capital and leverage capital guidelines. One approach being
considered by the Board is to generally treat the subordinated debt
associated with trust preferred securities issued by small BHCs as debt
for most purposes under the Small BHC Policy Statement (other than the
12-year debt reduction and 25-year debt retirement standards), except
that an amount of subordinated debt up to 25 percent of a small BHC's
GAAP total stockholders' equity, net of goodwill, would be considered
as neither debt nor equity under the Small BHC Policy Statement. This
approach would result in a treatment for trust preferred securities
issued by BHCs subject to the Small BHC Policy Statement that would be
more in line with the treatment of these securities that the Board is
proposing for larger BHCs subject to the Federal Reserve's risk-based
capital guidelines. The Board seeks comment on this approach and other
approaches to revision of the Small BHC Policy Statement to ensure a
fair and sound approach for small BHCs' issuances of trust preferred
securities.
The Board is also proposing to delete tables and attachments in the
risk-based capital standards for state member banks and BHCs that
summarize the definition of capital, the risk categories, credit
conversion factors, credit equivalent amount calculations, and
transitional arrangements to remove unnecessary regulatory text. These
tables and attachments have become outdated and unnecessary because the
substance of these summaries is included in the main text of the risk-
based capital standards. Furthermore, these summary tables and
attachments were originally provided to assist banking organizations
unfamiliar with the new framework during the transition period when the
Board's risk-based capital requirements were initially implemented.
The Board welcomes comments on all aspects of this notice of
proposed rulemaking.
Regulatory Flexibility Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, the
Board has determined that this proposed rule would not have a
significant impact on a substantial number of small entities in
accordance with the spirit and purposes of the Regulatory Flexibility
Act (5 U.S.C. 601 et seq.). The Board believes that this proposed rule
should not impact a substantial number of small banking organizations
because most small banking organizations are already substantially in
compliance, or will readily come into compliance within the proposed
three-year transition period, with the regulatory standards of this
proposed rule.
Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3506; 5 CFR 1320 Appendix A.1.), the Board reviewed the proposed
rulemaking under the authority delegated to the Board by the Office of
Management and Budget. No collections of information pursuant to the
Paperwork Reduction Act are contained in the proposed rulemaking.
Plain Language
Section 722 of the Gramm-Leach-Bliley (GLB) Act requires the Board
to use ``plain language'' in all proposed and final rules published
after January 1, 2000. In light of this requirement, the Board has
sought to present its proposed rule in a simple and straightforward
manner. The Board invites comment on whether there are additional steps
the Board could take to make its rule easier to understand.
List of Subjects
12 CFR Part 208
Accounting, Agriculture, Banks, Banking, Confidential business
information, Crime, Currency, Mortgages, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 225
Administrative practice and procedure, Banks, Banking, Holding
companies, Reporting and recordkeeping requirements, Securities.
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation of part 208 continues to read as follows:
Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a,
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 1823(j),
1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1831w, 1831x, 1835a, 1882,
2901-2907, 3105, 3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b,
78l(b), 781(g), 781(i), 78o-4(c)(5), 78q, 78q-1, and 78w; 31 U.S.C.
5318, 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128.
Appendix A to Part 208--[Amended]
2. In Appendix A to part 208, remove Attachments II, III, IV, V,
and VI.
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
3. The authority citation for part 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1,
1843(c)(8), 1844(b). 1972(l), 3106, 3108, 3310, 3331-3351, 3907, and
3909; 15 U.S.C. 6801 and 6805.
4. In Appendix A to part 225, the following amendments are
proposed:
a. In section II, designate the first three undesignated paragraphs
as paragraphs (i), (ii), and (iii); and revise redesignated paragraphs
(i), (ii) and (iii).
b. In section II.A.,
i. Revise the heading.
ii. Remove footnote 5.
c. Revise section II.A.1.
d. In section II.A.2.,
i. Revise the heading.
ii. Remove footnote 8.
iii. Redesignate footnotes 9 and 10 as footnotes 11 and 12.
iv. Revise paragraph b.
v. Revise paragraph d.
vi. Redesignate footnotes 14 through 61 as footnotes 15 through 62
respectively, and add new footnote 14.
e. Add a sentence at the end of newly redesignated footnote 17.
f. Revise newly redesignated footnotes 38 and 39.
g. Remove Attachments II, III, IV, V, and VI.
Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
* * * * *
[[Page 28857]]
II. Definition of Qualifying Capital for the Risk-Based Capital Ratio
(i) A banking organization's qualifying total capital consists
of two types of capital components: ``core capital elements'' (tier
1 capital elements) and ``supplementary capital elements'' (tier 2
capital elements). These capital elements and the various limits,
restrictions, and deductions to which they are subject, are
discussed below. To qualify as an element of tier 1 or tier 2
capital, an instrument must be fully paid up and effectively
unsecured. Accordingly, if a banking organization has purchased, or
has directly or indirectly funded the purchase of, its own capital
instrument, that instrument generally is disqualified from inclusion
in regulatory capital. A qualifying tier 1 or tier 2 capital
instrument also must be subordinated to all senior indebtedness of
the organization. If issued by a bank, it also must be subordinated
to claims of depositors. In addition, the instrument must not
contain or be covered by any covenants, terms, or restrictions that
are inconsistent with safe and sound banking practices.
(ii) On a case-by-case basis, the Federal Reserve may determine
whether, and to what extent, any instrument that does not fit wholly
within the terms of a capital element set forth below, or that does
not have an ability to absorb losses commensurate with the capital
treatment specified below, will qualify as an element of tier 1 or
tier 2 capital. In making such a determination, the Federal Reserve
will consider the similarity of the instrument to instruments
explicitly treated in the guidelines; the ability of the instrument
to absorb losses, particularly while the organization operates as a
going concern; the maturity and redemption features of the
instrument; and other relevant terms and factors.
(iii) Redemptions of capital instruments before stated maturity
could have a significant impact on an organization's overall capital
structure. Consequently, an organization considering such a step
should consult with the Federal Reserve before redeeming any equity
or debt capital instrument prior to stated maturity if such
redemption could have a material effect on the level or composition
of the organization's capital base. Such consultation generally
would not be necessary when the instrument is to be redeemed with
the proceeds of, or replaced by, a like amount of a capital
instrument that is of equal or higher quality with regard to terms
and maturity and the Federal Reserve considers the organization's
capital position to be fully sufficient.
A. The Definition and Components of Qualifying Capital
1. Tier 1 capital. Tier 1 capital generally is defined as the
sum of core capital elements less any amounts of goodwill, other
intangible assets, interest-only strips receivables, deferred tax
assets, nonfinancial equity investments, and other items that are
required to be deducted in accordance with section II.B. of this
appendix. Tier 1 capital must represent at least 50 percent of total
qualifying capital.
a. Core capital elements (tier 1 capital elements). The elements
qualifying for inclusion in the tier 1 component of an institution's
total qualifying capital are:
i. Qualifying common stockholders' equity;
ii. Qualifying noncumulative perpetual preferred stock
(including related surplus);
iii. Minority interest related to qualifying common or
noncumulative perpetual preferred stock directly issued by a
consolidated U.S. depository institution or foreign bank subsidiary
(Class A minority interest); and
iv. Restricted core capital elements. The aggregate of these
items is limited within tier 1 capital as set forth in section
II.A.1.b. of this appendix. These elements are defined to include:
(1) Qualifying cumulative perpetual preferred stock (including
related surplus);
(2) Minority interest related to qualifying cumulative perpetual
preferred stock directly issued by a consolidated U.S. depository
institution or foreign bank subsidiary (Class B minority interest);
(3) Minority interest in the form of qualifying common
stockholders' equity or qualifying perpetual preferred stock (and
related surplus) in a consolidated subsidiary that is neither a U.S.
depository institution nor a foreign bank (Class C minority
interest); and
(4) Qualifying trust preferred securities.
b. Limits on restricted core capital elements--i. Limits. (1)
The aggregate amount of restricted core capital elements that may be
included in a banking organization's tier 1 capital must not exceed
25 percent of the sum of all core capital elements, including
restricted core capital elements, net of goodwill. Stated
differently, the aggregate amount of restricted core capital
elements is limited to one-third of the sum of core capital
elements, excluding restricted core capital elements, net of
goodwill. Amounts of restricted core capital elements in excess of
this limit generally may be included in tier 2 capital.
(2) The excess amounts of restricted core capital elements that
are in the form of Class C minority interest and qualifying trust
preferred securities are subject to further limitation within tier 2
capital in accordance with section II.A.2.d.iv. of this appendix. A
banking organization may attribute excess amounts of restricted core
capital elements first to any qualifying cumulative perpetual
preferred stock or to Class B minority interest, and second to
qualifying trust preferred securities or to Class C minority
interest, which are subject to a tier 2 sublimit.
(3) The Federal Reserve generally expects internationally active
banking organizations to limit the aggregate amount of restricted
core capital elements included in tier 1 capital to 15 percent of
the sum of all core capital elements, including restricted core
capital elements, net of goodwill.
ii. Transition.
(1) The quantitative limits for restricted core capital elements
set forth in sections II.A.1.b.i. and II.A.2.d.iv. of this appendix
do not become effective until March 31, 2007. Prior to that time, a
banking organization with restricted core capital elements in
amounts that cause them to exceed these limits must consult with the
Federal Reserve on a plan for ensuring that the banking organization
is not unduly relying on these elements in its capital base and,
where appropriate, for reducing such reliance.
(2) Until March 31, 2007, the aggregate amount of qualifying
cumulative perpetual preferred stock (including related surplus) and
qualifying trust preferred securities that a banking organization
may include in tier 1 capital is limited to 25 percent of the sum of
the following core capital elements: qualifying common stockholders'
equity, qualifying noncumulative and cumulative perpetual preferred
stock (including related surplus), qualifying minority interest in
the equity accounts of consolidated subsidiaries, and qualifying
trust preferred securities. Until March 31, 2007, amounts of
qualifying cumulative perpetual preferred stock and qualifying trust
preferred securities in excess of this limit may be included in tier
2 capital.
(3) Until March 31, 2007, internationally active banking
organizations generally are expected to limit the amount of
qualifying cumulative perpetual preferred stock and qualifying trust
preferred securities included in tier 1 capital to 15 percent of the
sum of core capital elements set forth in section II.A.1.b.ii.(2) of
this appendix.
c. Definitions and requirements for core capital elements.
i. Qualifying common stockholders' equity.
(1) Definition. Qualifying common stockholders' equity is
limited to common stock; related surplus; and retained earnings,
including capital reserves and adjustments for the cumulative effect
of foreign currency translation, net of any treasury stock, less net
unrealized holding losses on available-for-sale equity securities
with readily determinable fair values. For this purpose, net
unrealized holding gains on such equity securities and net
unrealized holding gains (losses) on available-for-sale debt
securities are not included in qualifying common stockholders'
equity.
(2) Restrictions on terms and features. A capital instrument
that has a stated maturity date or that has a preference with regard
to liquidation or the payment of dividends is not deemed to be a
component of qualifying common stockholders' equity, regardless of
whether or not it is called common equity. Terms or features that
grant other preferences also may call into question whether the
capital instrument would be deemed to be qualifying common
stockholders' equity. Features that require, or provide significant
incentives for, the issuer to redeem the instrument for cash or cash
equivalents will render the instrument ineligible as a component of
qualifying common stockholders' equity.
(3) Reliance on voting common stockholders' equity. Although
section II.A.1. of this appendix allows for the inclusion of
elements other than common stockholders' equity within tier 1
capital, voting common stockholders' equity, which is the most
desirable capital element from a supervisory standpoint, generally
should be the dominant element within tier 1 capital. Thus, bank
holding companies should avoid over-reliance on preferred stock or
other nonvoting elements within tier 1 capital. Such nonvoting
elements can include
[[Page 28858]]
portions of common stockholders' equity where, for example, a
banking organization has a class of nonvoting common equity, or a
class of voting common equity that has substantially fewer voting
rights per share than another class of voting equity. Where a
banking organization relies excessively on nonvoting elements within
tier 1 capital, the Federal Reserve generally will require the
banking organization to allocate a portion of the nonvoting elements
to tier 2 capital.
ii. Qualifying perpetual preferred stock.
(1) Qualifying requirements. Perpetual preferred stock
qualifying for inclusion in tier 1 capital has no maturity date,
cannot be redeemed at the option of the holder, and has no other
provisions or features that will require, or create significant
incentives for, future redemption of the issue. Perpetual preferred
stock will qualify for inclusion in tier 1 capital only if it can
absorb losses while the issuer operates as a going concern and only
if the issuer has the ability and legal right to defer or eliminate
dividends on the preferred stock.
(2) Restrictions on terms and features. Perpetual preferred
stock included in tier 1 capital may not have any provisions
restricting the banking organization's ability to defer or eliminate
dividends, other than provisions requiring prior or concurrent
deferral of payments on more junior instruments, which the Federal
Reserve generally expects in such instruments consistent with the
notion that the most junior capital elements should absorb losses
first. Dividend deferrals on preferred stock, which the Federal
Reserve expects will occur either voluntarily or at its direction
when an organization is in a weakened condition, must not be subject
to arrangements that would diminish the ability of the deferral to
shore up the organization's resources. Any perpetual preferred stock
with a feature permitting redemption at the option of the issuer may
qualify as tier 1 capital only if the redemption is subject to prior
approval of the Federal Reserve. Features that require, or create
significant incentives for, the issuer to redeem the instrument for
cash or cash equivalents generally will render the instrument
ineligible for inclusion in tier 1 capital. For example, perpetual
preferred stock that has a credit-sensitive dividend feature--that
is, a dividend rate that is reset periodically based, in whole or in
part, on the banking organization's current credit standing--
generally does not qualify for inclusion in tier 1 capital.\5\
Similarly, perpetual preferred stock that has a dividend rate step-
up or a market value conversion feature--that is, a feature whereby
the holder must or can convert the preferred stock into common stock
at the market price prevailing at the time of conversion--generally
does not qualify for inclusion in tier 1 capital.\6\ Perpetual
preferred stock that does not qualify for inclusion in tier 1
capital generally will qualify for inclusion in tier 2 capital.
---------------------------------------------------------------------------
\5\ Traditional floating-rate or adjustable-rate perpetual
preferred stock (that is, perpetual preferred stock in which the
dividend rate is not affected by the issuer's credit standing or
financial condition but is adjusted periodically in relation to an
independent index based solely on general market interest rates),
however, generally qualifies for inclusion in tier 1 capital
(provided all other requirements are met).
\6\ Traditional convertible perpetual preferred stock, which the
holder must or can convert into a fixed number of common shares at a
preset price, generally qualifies for inclusion in tier 1 capital
(provided all other requirements are met).
---------------------------------------------------------------------------
(3) Noncumulative and cumulative features. Perpetual preferred
stock that is noncumulative generally may not permit the accrual or
payment of unpaid dividends in any form, including in the form of
common stock. Perpetual preferred stock that provides for the
accumulation or future payment of unpaid dividends is deemed to be
cumulative, regardless of whether or not it is called noncumulative.
iii. Qualifying minority interest. Minority interest in the
common and preferred stockholders' equity accounts of a consolidated
subsidiary (minority interest) represents stockholders' equity
associated with common or preferred equity instruments issued by a
banking organization's consolidated subsidiary that are held by
investors other than the banking organization. Minority interest is
included in tier 1 capital because, as a general rule, it represents
equity that is freely available to absorb losses in the issuing
subsidiary. Nonetheless, minority interest typically is not
available to absorb losses in the banking organization as a whole, a
feature that is a particular concern when the minority interest is
issued by a subsidiary that is neither a U.S. depository institution
nor a foreign bank. For this reason, these guidelines distinguish
among three types of qualifying minority interest. Class A minority
interest is limited to minority interest related to qualifying
common and noncumulative perpetual preferred equity instruments
issued directly (that is, not through a subsidiary) by a
consolidated U.S. depository institution \7\ or foreign bank \8\
subsidiary of a banking organization. Class A minority interest is
not subject to a formal limitation within tier 1 capital. Class B
minority interest is limited to minority interest related to
qualifying cumulative perpetual preferred equity instruments issued
directly by a consolidated U.S. depository institution or foreign
bank subsidiary of a banking organization. Class B minority interest
is a restricted core capital element subject to the limitation set
forth in section II.A.1.b.i. of this appendix, but is not subject to
a tier 2 sublimit. Class C minority interest includes any minority
interest related to qualifying common or perpetual preferred equity
instruments that are issued by a banking organization's consolidated
subsidiary that is neither a U.S. depository institution nor a
foreign bank. Class C minority interest is eligible for inclusion in
tier 1 capital as a restricted core capital element and is subject
to the limitations set forth in section II.A.1.b.i. and II.A.2.d.iv.
of this appendix. Minority interest in small business investment
companies, investment funds that hold nonfinancial equity
investments (as defined in section II.B.5.b. of this appendix), and
subsidiaries engaged in nonfinancial activities are not included in
the banking organization's tier 1 or total capital base if the
banking organization's interest in the company or fund is held under
one of the legal authorities listed in section II.B.5.b. of this
appendix. In addition, minority interest in consolidated asset-
backed commercial paper programs (as defined in section III.B.6. of
this appendix) that are sponsored by a banking organization are not
included in the organization's tier 1 or total capital base if the
organization excludes the consolidated assets of the program from
risk-weighted assets pursuant to section III.B.6. of this appendix.
This capital treatment for minority interest in consolidated asset-
backed commercial paper programs will be effective from July 1, 2003
and will expire on July 1, 2004.
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\7\ U.S. depository institutions are defined to include branches
(foreign and domestic) of federally insured banks and depository
institutions chartered and headquartered in the 50 states of the
United States, the District of Columbia, Puerto Rico, and U.S.
territories and possessions. The definition encompasses banks,
mutual or stock savings banks, savings or building and loan
associations, cooperative banks, credit unions, and international
banking facilities of domestic banks.
\8\ For this purpose, a foreign bank is defined as an
institution that engages in the business of banking; is recognized
as a bank by the bank supervisory or monetary authorities of the
country of its organization or principal banking operations;
receives deposits to a substantial extent in the regular course of
business; and has the power to accept demand deposits.
---------------------------------------------------------------------------
iv. Qualifying trust preferred securities. A banking
organization that wishes to issue trust preferred securities and
include them in tier 1 capital must first consult with the Federal
Reserve. Trust preferred securities are defined as undated preferred
securities issued by a trust or similar entity sponsored by a
banking organization that is the sole common equity holder of the
trust. Qualifying trust preferred securities must allow for
dividends to be deferred for at least twenty consecutive quarters
without an event of default and any notification period for deferral
must be reasonably short, generally no more than one business week.
The securities are otherwise subject to the same restrictions on
terms and features as qualifying perpetual preferred stock as set
forth in section II.A.c.ii.(2) of this appendix and must provide for
a call at the banking organization's option commencing no later than
ten years from the date of issuance. Further, the sole asset of the
trust generally must be a subordinated note, issued by the
sponsoring banking organization, that has a minimum maturity of
thirty years, is subordinated to all senior and all other
subordinated debt of the banking organization, and otherwise has
terms that mirror those of the preferred securities issued by the
trust.\9\ The note may have terms
[[Page 28859]]
providing for an event of default and acceleration of principal and
accrued interest upon deferral of payments for twenty or more
consecutive quarters but otherwise must comply with the Federal
Reserve's subordinated debt policy statement set forth in 12 CFR
250.166.\10\ In the last five years before the maturity of the note,
the outstanding amount of the associated trust preferred securities
are excluded from tier 1 capital and included in tier 2 capital,
where they are subject to the amortization provisions and
quantitative restrictions set forth in sections II.A.2.d.iii. and
iv. of this appendix as if the trust preferred securities were
limited-life preferred stock.
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\9\ Under generally accepted accounting principles, the trust
issuing the preferred securities generally is not consolidated on
the banking organization's balance sheet; rather the underlying
subordinated note is recorded as a liability on the organization's
balance sheet. Only the amount of the trust preferred securities
issued, which is equal to the amount of the underlying subordinated
note less the amount of the sponsoring banking organization's common
equity investment in the trust (which is recorded as an asset on the
banking organization's consolidated balance sheet), may be included
in tier 1 capital. The common equity investment in the trust should
be excluded from the calculation of risk-weighted assets in
accordance with footnote 15 of this appendix. Where a banking
organization has issued trust preferred securities pursuant to a
pooling arrangement, the organization generally must not buy back a
security issued from the pool. Where a banking organization does
hold such a security (for example, as a result of an acquisition of
another banking organization), the amount of the trust preferred
securities included in regulatory capital must, consistent with
section II.(i) of this appendix, be reduced by the notional amount
of the banking organization's investment in the security issued by
the pool.
\10\ Trust preferred securities issued before May 31, 2004,
generally would not be ineligible for inclusion in tier 1 capital
because of noncompliance with 12 CFR 250.166 provided the non-
complying terms of the subordinated note (i) have been commonly used
by banking organizations, (ii) do not provide an unreasonably high
degree of protection to the holder in circumstances other than
bankruptcy of the banking organization, and (iii) do not effectively
allow a holder in due course of the note to stand ahead of senior or
subordinated debt holders in the event of bankruptcy of the banking
organization.
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2. Supplementary capital elements (tier 2 capital elements) * *
*
* * * * *
b. Perpetual preferred stock. Perpetual preferred stock (and
related surplus) that meets the requirements set forth in section
II.A.1.c.ii.(1) of this appendix is eligible for inclusion in tier 2
capital without limit.\13\
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\13\ Long-term preferred stock with an original maturity of 20
years or more (including related surplus) will also qualify in this
category as an element of tier 2 capital. If the holder of such an
instrument has a right to require the issuer to redeem, repay, or
repurchase the instrument prior to the original stated maturity,
maturity would be defined for risk-based capital purposes as the
earliest possible date on which the holder can put the instrument
back to the issuing banking organization. In the last five years
before the maturity of the stock, it must be treated as limited-life
preferred stock, subject to the amortization provisions and
quantitative restriction set forth in section II.A.2.d.iii. and iv.
of this appendix. Minority interest in the form of preferred stock
(and related surplus) directly issued by a consolidated U.S.
depository institution or foreign bank subsidiary that does not
qualify for inclusion in tier 1 capital also generally is eligible
for inclusion in this category as an element of tier 2 capital.
---------------------------------------------------------------------------
* * * * *
d. Subordinated debt and intermediate-term preferred stock--i.
Five-year minimum maturity. Subordinated debt and intermediate-term
preferred stock must have an original weighted average maturity of
at least five years to qualify as tier 2 capital. If the holder has
the option to require the issuer to redeem, repay, or repurchase the
instrument prior to the original stated maturity, maturity would be
defined, for risk-based capital purposes, as the earliest possible
date on which the holder can put the instrument back to the issuing
banking organization.
ii. Other restrictions on subordinated debt. Subordinated debt
included in tier 2 capital must comply with the Federal Reserve's
subordinated debt policy statement set forth in 12 CFR 250.166.\14\
Accordingly, such subordinated debt must meet the following
requirements:
---------------------------------------------------------------------------
\14\ The subordinated debt policy statement set forth in 12 CFR
250.166 notes that certain terms found in subordinated debt may
provide protection to investors without adversely affecting the
overall benefits of the instrument to the issuing banking
organization and, thus, would be acceptable for subordinated debt
included in capital. Among such acceptable terms would be a
provision that prohibits a bank holding company from merging,
consolidating, or selling substantially all of its assets unless the
new entity assumes the subordinated debt. Another acceptable
provision would be the inclusion as an event of default the failure
to pay principal or interest on a timely basis, so long as such
event of default does not allow the debtholders to accelerate the
repayment of principal or interest.
---------------------------------------------------------------------------
(1) The subordinated debt must be unsecured.
(2) The subordinated debt must clearly state on its face that it
is not a deposit and is not insured by a Federal agency.
(3) The subordinated debt must not have credit-sensitive
features or other provisions that are inconsistent with safe and
sound banking practice.
(4) Subordinated debt issued by a subsidiary depository
institution of a bank holding company must be subordinated in right
of payment to the claims of all the institution's general creditors
and depositors, and must not contain provisions permitting debt
holders to accelerate payment of principal or interest upon the
occurrence of any event other than receivership of the institution.
Subordinated debt issued by a bank holding company or its non-
depository institution subsidiaries must be subordinated to all
senior indebtedness of the issuer; that is, the debt must be
subordinated at a minimum to all borrowed and purchased money,
similar obligations arising from off-balance sheet guarantees and
direct credit substitutes, and obligations associated with
derivative products such as interest rate and foreign exchange
contracts, commodity contracts, and similar arrangements.
Subordinated debt issued by a bank holding company or its non-
depository institution subsidiaries must not contain provisions
permitting debt holders to accelerate payment of principal or
interest upon the occurrence of any event other than bankruptcy of
the bank holding company or the receivership of a major subsidiary
depository institution. Thus, a provision permitting acceleration in
the event that any other affiliate of the bank holding company
issuer enters into bankruptcy or receivership makes the instrument
ineligible for inclusion in tier 2 capital.
iii. Discounting in last five years. As a limited-life capital
instrument approaches maturity, it begins to take on characteristics
of a short-term obligation. For this reason, the outstanding amount
of term subordinated debt and limited-life preferred stock eligible
for inclusion in tier 2 capital is reduced, or discounted, as these
instruments approach maturity: one-fifth of the outstanding amount
is excluded each year during the instrument's last five years before
maturity. When remaining maturity is less than one year, the
instrument is excluded from tier 2 capital.
iv. Limits. The aggregate amount of term subordinated debt
(excluding mandatory convertible debt) and limited-life preferred
stock--as well as, beginning March 31, 2007, qualifying trust
preferred securities and Class C minority interest in excess of the
limits set forth in section II.A.1.b.i. of this appendix--that may
be included in tier 2 capital is limited to 50 percent of tier 1
capital (net of goodwill and other intangible assets required to be
deducted in accordance with section II.B.1.b. of this appendix).
Amounts of these instruments in excess of this limit, although not
included in tier 2 capital, will be taken into account in the
overall assessment of an organization's funding and financial
condition.
B. * * *
2. * * *
a. * * * The aggregate amount of investments in banking or
finance subsidiaries \17\ * * *
---------------------------------------------------------------------------
\17\ * * * For the purpose of this section, the definition of
banking and finance subsidiary does not include a trust or other
special purpose entity used to issue trust preferred securities.
---------------------------------------------------------------------------
* * * * *
III. * * *
C. * * *
2. * * *
a. * * * U.S. depository institutions \38\ and foreign banks
\39\; * * *
---------------------------------------------------------------------------
\38\ See footnote 7 of this appendix for the definition of a
U.S. depository institution. For this purpose, the definition also
includes U.S.-chartered depository institutions owned by foreigners.
However, branches and agencies of foreign banks located in the U.S.,
as well as all bank holding companies, are excluded.
\39\ See footnote 8 of this appendix for the definition of a
foreign bank. Foreign banks are distinguished as either OECD banks
or non-OECD banks. OECD banks include banks and their branches
(foreign and domestic) organized under the laws of countries (other
than the U.S.) that belong to the OECD-based group of countries.
Non-OECD banks include banks and their branches (foreign and
domestic) organized under the laws of countries that do not belong
to the OECD-based group of countries.
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* * * * *
5. In Appendix D to Part 225, the following amendments are
proposed:
a. Amend the second sentence of section I.b. by changing the word
``that'' to ``than.''
b. In section II.b., revise footnote 3.
c. In section II.c., revise the second sentence.
Appendix D to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Tier 1 Leverage Measure
* * * * *
[[Page 28860]]
II. * * *
b. * * * For the purpose of this leverage ratio, the definition
of tier 1 capital as set forth in the risk-based capital guidelines
contained in appendix A of this part will be used.\3\ * * *
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\3\ Tier 1 capital for banking organizations includes the
following core capital elements: qualifying common stockholders'
equity, qualifying noncumulative and cumulative perpetual preferred
stock, qualifying minority interest in the equity accounts of
consolidated subsidiaries, and qualifying trust preferred
securities. Qualifying cumulative perpetual preferred stock and
trust preferred securities, as well as, beginning March 31, 2007,
certain types of minority interest, are limited to 25 percent of the
sum of core capital elements, net, beginning March 31, 2007, of
goodwill. Internationally active banking organizations generally are
expected to limit these elements to 15 percent of the sum of tier 1
capital elements, net, beginning March 31, 2007, of goodwill. In
addition, as a general matter, tier 1 capital excludes goodwill;
amounts of mortgage-servicing assets, non-mortgage-servicing assets,
and purchased credit-card relationships that, in the aggregate,
exceed 100 percent of tier 1 capital; amounts of non-mortgage-
servicing assets and purchased credit-card relationships that, in
the aggregate, exceed 25 percent of tier 1 capital; amounts of
credit-enhancing interest-only strips that are in excess of 25
percent of tier 1 capital; all other identifiable intangible assets;
deferred tax assets that are dependent upon future taxable income,
net of their valuation allowance in excess of certain limitations;
and a percentage of the organization's nonfinancial equity
investments. The Federal Reserve may exclude certain investments in
subsidiaries or associated companies as appropriate.
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c. * * * This is consistent with the Federal Reserve's risk-
based capital guidelines and long-standing Board policy and practice
with regard to leverage guidelines. * * *
* * * * *
By order of the Board of Governors of the Federal Reserve
System, May 6, 2004.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 04-10728 Filed 5-18-04; 8:45 am]
BILLING CODE 6210-01-P