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6000 - Bank Holding Company Act
Appendix BCapital Adequacy Guidelines for Bank Holding Companies
and State Member Banks: Leverage Measure
The Board of Governors of the Federal Reserve System has adopted
minimum capital ratios and guidelines to provide a framework for
assessing the adequacy of the capital of bank holding companies and
state member banks (collectively "banking organizations"). The
guidelines generally apply to all state member banks and bank holding
companies regardless of size and are to be used in the examination and
supervisory process as well as in the analysis of applications acted
upon by the Federal Reserve. The Board of Governors will review the
guidelines from time to time for possible adjustment commensurate with
changes in the economy, financial markets, and banking practices. In
this regard, the Board has determined that during the transition period
through year-end 1990 for implementation of the risk-based capital
guidelines contained in appendix A to this part and in appendix A to
Part 208, a banking organization may choose to fulfill the requirements
of the guidelines relating capital to total assets contained in this
appendix in one of two manners. Until year-end 1990, a banking
organization may choose to conform to either the 5.5 percent and 6
percent minimum primary and total capital standards set forth in this
appendix, or the 7.25 percent year-end 1990 minimum risk-based capital
standard set forth in appendix A to this part and appendix A to Part
208. Those organizations that choose to conform during this period to
the 7.25 percent year-end 1990 risk-based capital standard will be
deemed to be in compliance with the capital adequacy guidelines set
forth in this appendix.
Two principal measurements of capital are used--the primary capital
ratio and the total capital ratio. The definitions of primary and total
capital for banks and bank holding companies and formulas for
calculating the capital ratios are set forth below in the definitional
sections of these guidelines.
{{10-31-08 p.6120.18-A}}
Capital Guidelines
The Board has established a minimum level of primary capital to
total assets of 5.5 percent and a minimum level of total capital
to total assets of 6.0 percent. Generally, banking organizations are
expected to operate above the minimum primary and total capital levels.
Those organizations whose operations involve or are exposed to high or
inordinate degrees of risk will be expected to hold additional capital
to compensate for these risks.
In addition, the Board has established the following three zones for
total capital for banking organizations of all sizes:
TOTAL CAPITAL RATIO (In
percent)
Zone
1 |
Above 7.0. |
Zone 2 |
6.0 to 7.0. |
Zone
3 |
Below 6.0.
|
The capital guidelines assume adequate liquidity and a
moderate amount of risk in the loan and investment portfolios and in
off-balance sheet activities. The Board is concerned that some banking
organizations may attempt to comply with the guidelines in ways that
reduce their liquidity or increase risk. Banking organizations should
avoid the practice of attempting to meet the guidelines by decreasing
the level of liquid assets in relation to total assets. In assessing
compliance with the guidelines, the Federal Reserve will take into
account liquidity and the overall degree of risk associated with an
organization's operations, including the volume of assets exposed to
risk.
The Federal Reserve will also take into account the sale of loans or
other assets with recourse and the volume and nature of all off-balance
sheet risk. Particularly close attention will be directed to risks
associated with standby letters of credit and participation in joint
venture activities. The Federal Reserve will review the relationship of
all on- and off-balance sheet risks to capital and will require those
institutions with high or inordinate levels of risk to hold additional
primary capital. In addition, the Federal Reserve will continue to
review the need for more explicit procedures for factoring on- and
off-balance sheet risks into the assessment of capital adequacy.
The capital guidelines apply to both banks and bank holding
companies on a consolidated
basis. 1
Some banking organizations are engaged in significant nonbanking
activities that typically require capital ratios higher than those of
commercial banks alone. The Board believes that, as a matter of both
safety and soundness and competitive equity, the degree of leverage
common in banking should not automatically extend to nonbanking
activities. Consequently, in evaluating the consolidated capital
positions of banking organizations, the Board is placing greater weight
on the building-block approach for assessing capital requirements. This
approach generally provides that nonbank subsidiaries of a banking
organization should maintain levels of capital consistent with the
levels that have been established by industry norms or standards, by
federal or state regulatory agencies for similar firms that are not
affiliated with banking organizations, or that may be established by
the Board after taking into account risk factors of a particular
industry. The assessment of an organization's consolidated capital
adequacy must take into account the amount and nature of all nonbank
activities, and an institution's consolidated capital position should
at least equal the sum of the capital requirements of the
organization's bank and nonbank subsidiaries as well as those of the
parent company.
[The page following this is 6120.18-E.]
{{12-31-98 p.6120.18-E}}
Supervisory Action
The nature and intensity of supervisory action will be determined by
an organization's compliance with the required minimum primary capital
ratio as well as by the zone in which the company's total capital ratio
falls. Banks and bank holding companies with primary capital ratios
below the 5.5 percent minimum will be considered undercapitalized
unless they can demonstrate clear extenuating circumstances. Such
banking organizations will be required to submit an acceptable plan for
achieving compliance with the capital
{{2-28-93 p.6120.19}}guidelines and will be subject to
denial of applications and appropriate supervisory enforcement actions.
The zone in which an organization's total capital ratio falls will
normally trigger the following supervisory responses, subject to
qualitative analysis:
For institutions operating in Zone 1, the Federal Reserve will:
--Consider that capital is generally adequate if the primary
capital ratio is acceptable to the Federal Reserve and is above the 5.5
percent minimum.
For institutions operating in Zone 2, the Federal Reserve will:
--Pay particular attention to financial factors, such as asset
quality, liquidity, off-balance sheet risk, and interest rate risk, as
they relate to the adequacy of capital. If these areas are deficient
and the Federal Reserve concludes capital is not fully adequate, the
Federal Reserve will intensify its monitoring and take appropriate
supervisory action.
For institutions operating in Zone 3, the Federal Reserve will:
--Consider that the institution is undercapitalized, absent clear
extenuating circumstances;
--Require the institution to submit a comprehensive capital plan,
acceptable to the Federal Reserve, that includes a program for
achieving compliance with the required minimum ratios within a
reasonable time period; and
--Institute appropriate supervisory and/or administrative
enforcement action, which may include the issuance of a capital
directive or denial of applications, unless a capital plan acceptable
to the Federal Reserve has been adopted by the institution.
Treatment of Intangible Assets for the Purpose of Assessing the
Capital Adequacy of Bank Holding Companies and State Member Banks
In considering the treatment of intangible assets for the purpose of
assessing capital adequacy, the Federal Reserve recognizes that the
determination of the future benefits and useful lives of certain
intangible assets may involve a degree of uncertainty that is not
normally associated with other banking assets. Supervisory concern over
intangible assets derives from this uncertainty and from the
possibility that, in the event an organization experiences financial
difficulties, such assets may not provide the degree of support
generally associated with other assets. For this reason, the Federal
Reserve will carefully review the level and specific character of
intangible assets in evaluating the capital adequacy of state member
banks and bank holding companies.
The Federal Reserve recognizes that intangible assets may differ
with respect to predictability of any income stream directly associated
with a particular asset, the existence of a market for the asset, the
ability to sell the asset, or the reliability of any estimate of the
asset's useful life. Certain intangible assets have predictable income
streams and objectively verifiable values and may contribute to an
organization's profitability and overall financial strength. The value
of other intangibles, such as goodwill, may involve a number of
assumptions and may be more subject to changes in general economic
circumstances or to changes in an individual institution's future
prospects. Consequently, the value of such intangible assets may be
difficult to ascertain. Consistent with prudent banking practices and
the principle of the diversification of risks, banking organizations
should avoid excessive balance sheet concentration in any category or
related categories of intangible assets.
Bank Holding Companies
While the Federal Reserve will consider the amount and nature of all
intangible assets, those holding companies with aggregate intangible
assets in excess of 25 percent of tangible primary capital
(i.e., stated primary capital less all intangible assets) or
those institutions with lesser, although still significant, amounts of
goodwill will be subject to close scrutiny. For the purpose of
assessing capital adequacy, the Federal Reserve may, on a case-by-case
basis, make adjustments to an organization's capital ratios based upon
the amount of intangible assets in excess of the 25 percent threshold
level or upon the specific character of the organization's intangible
assets in relation to its overall financial condition. Such adjustments
may require some organizations to raise additional capital.
{{2-28-93 p.6120.20}}
The Board expects banking organizations (including state member
banks) contemplating expansion proposals to ensure that pro forma
capital ratios exceed the minimum capital levels without significant
reliance on intangibles, particularly goodwill. Consequently, in
reviewing acquisition proposals, the Board will take into consideration
both the stated primary capital ratio (that is, the ratio without any
adjustment for intangible assets) and the primary capital ratio after
deducting intangibles. In acting on applications, the Board will take
into account the nature and amount of intangible assets and will, as
appropriate, adjust capital ratios to include certain intangible assets
on a case-by-case basis.
State Member Banks
State member banks with intangible assets in excess of 25 percent of
intangible primary capital will be subject to close scrutiny. In
addition, for the purpose of calculating capital ratios of state member
banks, the Federal Reserve will deduct goodwill from primary capital
and total capital. The Federal Reserve may, on a case-by-case basis,
make further adjustments to a bank's capital ratios based on the amount
of intangible assets (aside from goodwill) in excess of the 25 percent
threshold level or on the specific character of the bank's intangible
assets in relation to its overall financial condition. Such adjustments
may require some banks to raise additional capital.
In addition, state member banks and bank holding companies are
expected to review periodically the value at which intangible assets
are carried on their balance sheets to determine whether there has been
any impairment of value or whether changing circumstances warrant a
shortening of amortization periods. Institutions should make
appropriate reductions in carrying values and amortization periods in
light of this review, and examiners will evaluate the treatment of
intangible assets during on-site examinations.
Definition of Capital To Be Used in Determining Capital Adequacy
of Bank Holding Companies and State Member Banks
Primary Capital Components
The components of primary capital are:
--Common stock,
--Perpetual preferred stock (preferred stock that does not have a
stated maturity date and that may not be redeemed at the option of the
holder),
--Surplus (excluding surplus relating to limited-life preferred
stock),
--Undivided profits,
--Contingency and other capital reserves,
--Mandatory convertible
instruments 2
,
--Allowance for possible loan and lease losses (exclusive of
allocated transfer risk reserves),
--Minority interest in equity accounts of consolidated
subsidiaries,
--Perpetual debt instruments (for bank holding companies but not
for state member banks).
Limits on Certain Forms of Primary Capital
Bank Holding Companies. The maximum composite amount of
mandatory convertible securities, perpetual debt, and perpetual
preferred stock that may be counted as primary capital for bank holding
companies is limited to 33.3 percent of all primary capital, including
these instruments. Perpetual preferred stock issued prior to November
20, 1985 (or determined by the Federal Reserve to be in the process of
being issued prior to that date), shall continue to be included as
primary capital.
The maximum composite amount of mandatory convertible securities and
perpetual debt that may be counted as primary capital for bank
holding companies is limited to 20 percent of all primary capital,
including these instruments. The maximum amount of equity commitment
notes (a form of mandatory convertible securities) that may be
counted as primary capital for a bank holding company is limited to
10 percent of all primary
{{2-28-93 p.6120.21}}capital, including mandatory
convertible securities. Amounts outstanding in excess of these
limitations may be counted as secondary capital provided they meet the
requirements of secondary capital instruments.
State Member Banks. The composite limitations on the
amount of mandatory convertible securities and perpetual preferred
stock (perpetual debt is not primary capital for state member banks)
that may serve as primary capital for bank holding companies shall not
be applied formally to state member banks, although the Board shall
determine appropriate limits for these forms of primary capital on a
case-by-case basis.
The maximum amount of mandatory convertible securities that may be
counted as primary capital for state member banks is limited to
162/3 percent of all primary capital, including mandatory
convertible securities. Equity commitment notes, one form of mandatory
convertible securities, shall not be included as primary capital for
state member banks, except that notes issued by state member banks
prior to May 15, 1985, will continue to be included in primary capital.
Amounts of mandatory convertible securities in excess of these
limitations may be counted as secondary capital if they meet the
requirements of secondary capital instruments.
Secondary Capital Components
The components of secondary capital are:
--Limited-life preferred stock (including related surplus) and
--Bank subordinated notes and debentures and unsecured long-term
debt of the parent company and its nonbank subsidiaries.
Restrictions Relating to Capital Components
To qualify as primary or secondary capital, a capital instrument
should not contain or be covered by any convenants, terms, or
restrictions that are inconsistent with safe and sound banking
practices. Examples of such terms are those regarded as unduly
interfering with the ability of the bank or holding company to conduct
normal banking operations or those resulting in significantly higher
dividends or interest payments in the event of a deterioration in the
financial condition of the issuer.
The secondary components must meet the following conditions to
qualify as capital:
--The instrument must have an original weighted-average maturity
of at least seven years.
--The instrument must be unsecured.
--The instrument must clearly state on its face that it is not a
deposit and is not insured by a federal agency.
--Bank debt instruments must be subordinated to claims of
depositors.
--For banks only, the aggregate amount of limited-life preferred
stock and subordinate debt qualifying as capital may not exceed 50
percent of the amount of the bank's primary capital.
As secondary capital components approach maturity, the banking
organization must plan to redeem or replace the instruments while
maintaining an adequate overall capital position. Thus, the remaining
maturity of secondary capital components will be an important
consideration in assessing the adequacy of total capital.
Capital Ratios
The primary and total capital ratios for bank holding companies are
computed as follows:
Primary capital ratio:
Primary capital components/Total assets +
Allowance for loan and lease losses (exclusive of allocated transfer
risk reserves)
Total capital ratio:
Primary capital components + Secondary
capital components/Total assets + Allowance for loan and lease losses
(exclusive of allocated transfer risk reserves)
The primary and total capital ratios for state member banks are
computed as follows:
Primary capital ratio:
{{2-28-93 p.6120.22}}
Primary capital components--Goodwill/Average total
assets + Allowance for loan and lease losses (exclusive of allocated
transfer risk reserves)--Goodwill
Total capital ratio:
Primary capital components + Secondary capital
components--Goodwill/Average total assets + Allowance for loan and
lease losses (exclusive of allocated transfer risk reserves)--Goodwill
Generally, period-end amounts will be used to calculate bank holding
company ratios. However, the Federal Reserve will discourage temporary
balance sheet adjustments or any other "window dressing"
practices designed to achieve transitory compliance with the
guidelines. Banking organizations are expected to maintain adequate
capital positions at all times. Thus, the Federal Reserve will, on a
case-by-case basis, use average total assets in the calculation of bank
holding company capital ratios whenever this approach provides a more
meaningful indication of an individual holding company's capital
position.
For the calculation of bank capital ratios, "average total
assets" will generally be defined as the quarterly average total
assets figure reported on the bank's Report of Condition. If warranted,
however, the Federal Reserve may calculate bank capital ratios based
upon total assets as of period-end. All other components of the bank's
capital ratios will be based upon period-end balances.
Criteria for Determining the Primary Capital Status of Mandatory
Convertible Securities of Bank Holding Companies and State Member Banks
Mandatory convertible securities are subordinated debt instruments
that are eventually transformed into common or perpetual preferred
stock within a specified period of time, not to exceed 12 years. To be
counted as primary capital, mandatory convertible securities must meet
the criteria set forth below. These criteria cover the two basic types
of mandatory convertible securities: "equity contract
notes"--securities that obligate the holder to take common or
perpetual preferred stock of the issuer in lieu of cash for repayment
of principal, and "equity commitment notes"--securities that are
redeemable only with the proceeds from the sale of common or perpetual
preferred stock. Both equity commitment notes and equity contract notes
qualify as primary capital for bank holding companies, but only equity
contract notes qualify as primary capital for banks.
Criteria Applicable to Both Types of Mandatory
Convertible Securities
a. The securities must mature in 12 years or less.
b. The issuer may redeem securities prior to maturity only with the
proceeds from the sale of common or perpetual preferred stock of the
bank or bank holding company. Any exception to this rule must be
approved by the Federal Reserve. The securities may not be redeemed
with the proceeds of another issue of mandatory convertible securities.
Nor may the issuer repurchase or acquire its own mandatory convertible
securities for resale or reissuance.
c. Holders of the securities may not accelerate the payment of
principal except in the event of bankruptcy, insolvency, or
reorganization.
d. The securities must be subordinate in right of payment to all
senior indebtedness of the issuer. In the event that the proceeds of
the securities are reloaned to an affiliate, the loan must be
subordinated to the same degree as the original issue.
e. An issuer that intends to dedicate the proceeds of an issue of
common or perpetual preferred stock to satisfy the funding requirements
of an issue of mandatory convertible securities (i.e. the
requirement to retire or redeem the notes with the proceeds from the
issuance of common or perpetual preferred stock) generally must make
such a dedication during the quarter in which the new common or
preferred stock is issued. 3
{{2-28-97 p.6120.23}}rule, if the dedication is not
made within the prescribed period, then the securities issued may not
at a later date be dedicated to the retirement or redemption of the
mandatory convertible securities. 4
Additional Criteria Applicable to Equity Contract Notes
a. The note must contain a contractual provision (or must be issued
with a mandatory stock purchase contract) that requires the holder of
the instrument to take the common or perpetual stock of the issuer in
lieu of cash in satisfaction of the claim for principal repayment. The
obligation of the holder to take the common or perpetual preferred
stock of the issuer may be waived if, and to the extent that, prior to
the maturity date of the obligation, the issuer sells new common or
perpetual preferred stock and dedicates the proceeds to the retirement
or redemption of the notes. The dedication generally must be made
during the quarter in which the new common or preferred stock is
issued.
b. A stock purchase contract may be separated from a security only
if: (1) The holder of the contract provides sufficient
collateral 5
to the issuer, or to an independent trustee for the benefit of the
issuer, to assure performance under the contract and (2) the stock
purchase contract requires the purchase of common or perpetual
preferred stock.
Additional Criteria Applicable to Equity Commitment Notes
a. The indenture or note agreement must contain the following two
provisions:
1. The proceeds of the sale of common or perpetual preferred
stock will be the sole source of repayment for the notes, and the
issuer must dedicate the proceeds for the purpose of repaying the
notes. (Documentation certified by an authorized agent of the issuer,
showing the amount of common or perpetual preferred stock issued, the
dates of issue, and amounts of such issues dedicated to the retirement
or redemption of mandatory convertible securities will satisfy the
dedication requirement.)
2. By the time that one-third of the life of the securities has
run, the issuer must have raised and dedicated an amount equal to
one-third of the original principal of the securities. By the time that
two-thirds of the life of the securities has run, the issuer must have
raised and dedicated an amount equal to two-thirds of the original
principal of the securities. At least 60 days prior to the maturity of
the securities, the issuer must have raised and dedicated an amount
equal to the entire original principal of the securities. Proceeds
dedicated to redemption or retirement of the notes must come only from
the sale of common or perpetual preferred
stock. 6
b. If the issuer fails to meet any of these periodic funding
requirements, the Federal Reserve immediately will cease to treat the
unfunded securities as primary capital and will take appropriate
supervisory action. In addition, failure to meet the funding
requirements will be viewed as a breach of a regulatory commitment and
will be taken into consideration by the Board in acting on statutory
applications.
c. If a security is issued by a subsidiary of a bank or bank
holding company, any guarantee of the principal by that subsidiary's
parent bank or bank holding company must
{{2-28-97 p.6120.24}}be subordinate to the same degree
as the security issued by the subsidiary and limited to repayment of
the principal amount of the security at its final maturity.
Criteria for Determining the Primary Capital Status of
Perpetual Debt Instruments of Bank Holding Companies
1. The instrument must be unsecured and, if issued by a bank, must
be subordinated to the claims of depositors.
2. The instrument may not provide the noteholder with the right to
demand repayment of principal except in the event of bankruptcy,
insolvency, or reorganization. The instrument must provide that
nonpayment of interest shall not trigger repayment of the principal of
the perpetual debt note or any other obligation of the issuer, nor
shall it constitute prima facie evidence of insolvency or bankruptcy.
3. The issuer shall not voluntarily redeem the debt issue without
prior approval of the Federal Reserve, except when the debt is
converted to, exchanged for, or simultaneously replaced in like amount
by an issue of common or perpetual preferred stock of the issuer or the
issuer's parent company.
4. If issued by a bank holding company, a bank subsidiary, or a
subsidiary with substantial operations, the instrument must contain a
provision that allows the issuer to defer interest payments on the
perpetual debt in the event of, and at the same time as the elimination
of dividends on all outstanding common or preferred stock of the issuer
(or in the case of a guarantee by a parent company at the same time as
the elimination of the dividends of the parent company's common and
preferred stock). In the case of a nonoperating subsidiary (a funding
subsidiary or one formed to issue securities), the deferral of interest
payments must be triggered by elimination of dividends by the parent
company.
5. If issued by a bank holding company or a subsidiary with
substantial operations, the instrument must convert automatically to
common or perpetual preferred stock of the issuer when the issuer's
retained earnings and surplus accounts become negative. If an operating
subsidiary's perpetual debt is guaranteed by its parent, the debt may
convert to the shares of the issuer or guarantor and such conversion
may be triggered when the issuer's or parent's retained earnings and
surplus accounts become negative. If issued by a nonoperating
subsidiary of a bank holding company or bank, the instrument must
convert automatically to common or preferred stock of the issuer's
parent when the retained earnings and surplus accounts of the issuer's
parent become negative.
[Codified to 12 C.F.R. Part 225, Appendix B]
[Appendix B (formerly appendix A) amended at 50 Fed. Reg. 16066,
April 24, 1985, effective May 15, 1985; 51 Fed. Reg. 40969, November
12, 1986, effective November 4, 1986; redesignated as appendix B at 54
Fed. Reg. 4209, January 27, 1989, effective March 15, 1989; 55 Fed.
Reg. 32832, August 10, 1990, effective September 10, 1990; 58 Fed. Reg.
474, January 6, 1993]
1 The guidelines will apply to bank holding companies with less
than $150 million in consolidated assets on a bank-only basis unless: (1) The holding company or any nonbank subsidiary is engaged
directly or indirectly in any nonbank activity involving significant
leverage or (2) The holding company or any nonbank subsidiary has outstanding
significant debt held by the general public. Debt held by the general
public is defined to mean debt held by parties other than financial
institutions, officers, directors, and controlling shareholders of the
banking organization or their related interests. Go Back to Text
2 See the definitional section below that lists the criteria
for mandatory convertible instruments to qualify as primary capital. Go Back to Text
3 Common or perpetual preferred stock issued under dividend
reinvestment plans or issued to finance acquisitions, including
acquisitions of business entities, may be dedicated to the retirement
or redemption of the mandatory convertible securities. Documentation
certified by an authorized agent of the issuer showing the amount
of common stock or perpetual preferred stock issued, the dates of
issue, and amounts of such issues dedicated to the retirement or
redemption of mandatory convertible securities will satisfy the
dedication requirement. Go Back to Text
4 The dedication procedure is necessary to ensure that the
primary capital of the issuer is not overstated. For each dollar of
common or perpetual preferred proceeds dedicated to the retirement or
redemption of the notes, there is a corresponding reduction in the
amount of outstanding mandatory securities that may qualify as primary
capital. De minimis amounts (in relation to primary capital)
of common or perpetual preferred stock issued under arrangements in
which the amount of stock issued is not predictable, such as dividend
reinvestment plans and employee stock option plans (but excluding
public stock offerings and stock issued in connection with
acquisitions), should be dedicated by no later than the company's
fiscal year end. Go Back to Text
5 Collateral is defined as: (1) Cash or certificates of
deposit; (2) U.S. government securities that will mature prior to or
simultaneous with the maturity of the equity contract and that have a
par or maturity value at least equal to the amount of the holder's
obligation under the stock purchase contract; (3) standby letters of
credit issued by an insured U.S. bank that is not an affiliate of the
issuer; or (4) other collateral as may be designated from time to time
by the Federal Reserve. Go Back to Text
6 The funded portions of the securities will be deducted from
primary capital to avoid double counting. Go Back to Text
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