On June 25, 2010, after several weeks of deliberations, the Senate and House of Representatives conferees ("Conferees") approved the conference report (the "Conference Report") that reconciles the House-passed version of financial regulatory reform ("H.R. 4173") and the Restoring American Financial Stability Act of 2010 recently passed by the Senate (the "Senate Bill"). The Senate Bill included language authored by Senator Susan Collins (R-Maine) and supported by Federal Deposit Insurance Corporation ("FDIC") Chairman Sheila C. Bair, which would have, among other things, eliminated Tier 1 capital treatment for trust preferred securities ("TRUPS") at the holding company level ("Collins Amendment"). The Conference Report softens the potential impact of the Collins Amendment by (1) permitting small bank holding companies to continue to issue TRUPS and have them count as Tier 1 capital, (2) grandfathering Tier 1 capital treatment for TRUPS issued before May 19, 2010, by bank holding companies with less than $15 billion in consolidated assets as of December 31, 2009, and by organizations that were mutual holding companies on May 19, 2010, (3) permitting savings and loan holding companies with less than $15 billion in consolidated assets as of December 31, 2009, to include TRUPS issued before May 19, 2010, as Tier 1 capital once such savings and loan holding companies become subject to consolidated capital requirements and (4) providing for a phase-in period for the elimination of TRUPS as an element of Tier 1 capital.

The full 2315 page Conference Report is now posted on the House Financial Services Committee and the House Rules Committee Web sites, along with the House Financial Services Committee's summary of the Conference Report.

A. General Description of the Collins Amendment.

The Collins Amendment, as set forth in Section 171 of the Senate Bill, directed federal banking regulators to establish minimum leverage and risk-based capital requirements on a consolidated basis for insured depository institutions, depository institution holding companies and nonbank financial companies identified under Section 113 of the Senate Bill. Such minimum leverage and risk-based capital requirements were not to be less than the requirements that currently apply to insured depository institutions under the prompt corrective action regulations implementing Section 38 of the Federal Deposit Insurance Act, as amended. Thus, under the Collins Amendment:

  • bank regulators would be required to apply to bank holding companies, at a minimum, the current leverage and risk-based capital standards that insured depository institutions must follow;
  • savings and loan holding companies would become subject to consolidated capital requirements to which they were not previously subject when regulated by the Office of Thrift Supervision; and
  • bank regulators would be required to adopt, for all institutions covered by the Collins Amendment, capital requirements that address the risks that the activities of such institutions pose.

These measures are included in the Conference Report. By applying to bank holding companies and savings and loan holding companies the current capital standards that depository institutions must follow, the Collins Amendment also would have caused TRUPS to be excluded from Tier 1 capital at the holding company level. Presently, TRUPS enjoy Tier 1 capital treatment only for bank holding companies on a consolidated basis due to explicit regulations issued by the Board of Governors of the Federal Reserve System ("Federal Reserve"). However, TRUPS are not specifically addressed in any capital regulations applicable to depository institutions. TRUPS issued directly by a depository institution generally are not counted as an element of Tier 1 capital, but count only as Tier 2 capital for such depository institution. Likewise, under the terms of the Collins Amendment, as originally drafted, any TRUPS that were issued by holding companies would no longer count as Tier 1 capital, but would instead count only as Tier 2 capital.

B. Conference Report Reduces the Impact of the Collins Amendment on TRUPS.

The Conference Report scales back the effects of the Collins Amendment, as originally drafted, on the capital treatment of TRUPS. Specifically, the Conference Report provides that:

  • small bank holding companies that are subject to the Small Bank Holding Company Policy Statement of the Federal Reserve, as in effect on May 19, 2010 (generally those bank holding companies with less than $500 million of assets), would be permitted to continue to issue TRUPS and have them count as Tier 1 capital;
  • Tier 1 capital treatment would be grandfathered for TRUPS issued before May 19, 2010, by bank holding companies with consolidated assets of less than $15 billion as of December 31, 2009;
  • bank holding companies with $15 billion or more of consolidated assets as of December 31, 2009, will face a three-year phase-in period for the elimination of TRUPS as Tier 1 capital, beginning in January 2013, for any TRUPS issued before May 19, 2010 (effectively a five year phase-in period);
  • savings and loan holding companies will become subject to consolidated capital requirements applicable to depository institutions on the 5th anniversary of the effective date of the final legislation:
    • those with $15 billion or more of consolidated assets as of December 31, 2009, will not be able to include any TRUPS as Tier 1 capital;
    • though not expressly stated in the Conference Report, those with less than $15 billion of consolidated assets as of December 31, 2009, appear to be able to include TRUPS issued prior to May 19, 2010, in Tier 1 capital;
  • Any TRUPS issued by any depository institution holding company (other than small bank holding companies) after May 19, 2010, will no longer count as Tier 1 capital and will not be subject to any phase-in period; however, TRUPS will still be entitled to be treated as Tier 2 capital.

C. Potential Effects of Elimination of TRUPS as an Element of Tier 1 Capital.

1. Reduction in Current Capital Levels for Bank Holding Companies.

Despite the softening of the Collins Amendment from its original form, the impact of the Collins Amendment on bank holding companies with $15 billion or more ("Affected BHCs") would be sizable. Assuming final regulatory reform legislation becomes law, Affected BHCs would no longer be permitted to count previously issued TRUPS as an element of Tier 1 capital after the phase-in period. Industry representatives have previously noted that the exclusion of TRUPS as a source of capital from bank holding companies, by itself, would have a negative impact on approximately 644 bank holding companies (most of which are midsize) and eliminate $129 billion in capital, supporting $1.3 trillion in assets, from the banking system. Although such numbers would not be as extreme under the revised Collins Amendment, because not all bank holding companies are Affected BHCs, the effects will still be significant. If TRUPS are excluded from Tier 1 capital, Affected BHCs may need to replace such capital or significantly shrink their balance sheets to offset such loss of capital, which would further reduce lending. Accordingly, Affected BHCs that currently rely on TRUPS being included as an element of Tier 1 capital to qualify as "well-capitalized" should begin to consider capital replacement strategies, such as public offerings and private placements of common stock, preferred stock and/or debt securities, as well as rights offerings, in order to take advantage of market opportunities to raise capital as they arise and ensure that they will remain well-capitalized when Tier 1 capital treatment for TRUPS is phased out.

2. Potential Effects on Affected Savings and Loan Holding Companies.

Under the Conference Report, savings and loan holding companies would now become subject to consolidated capital requirements. Although they have not previously been subject to consolidated capital requirements, many savings and loan holding companies have issued TRUPS. One reason they have issued TRUPS is to use the proceeds as Tier 1 capital for their depository institution subsidiaries. Another reason for savings and loan holding companies to issue TRUPS was to provide for the potential of becoming subject to consolidated capital requirements, and to take advantage of the Tier 1 capital treatment afforded to TRUPS in this event. When savings and loan holding companies with $15 billion or more of assets ("Affected SLHCs") become subject to consolidated capital requirements and are unable to include TRUPS as an element of Tier 1 capital, many Affected SLHCs will not have sufficient Tier 1 capital to be considered well-capitalized, and will need to consider capital replacement strategies in order to comply with their newly imposed consolidated capital requirements.

Savings and loan holding companies with consolidated assets below $15 billion, though newly subject to consolidated capital requirements, may be able to count previously issued TRUPS and thereby alleviate the potential need to raise capital. However, the legislative and regulatory bias in favor of common equity is clear and should be kept in mind for future capital planning strategies.

3. Potential Effects on Currently Outstanding TRUPS.

Most TRUPS issuances contain a five-year "no call" period (or ten years for older TRUPS issuances), and virtually all TRUPS issued since 1996 when the Federal Reserve first announced the inclusion of TRUPS as an element of Tier 1 capital contain provisions allowing for the redemption of the TRUPS at a "special event redemption price" in the event of certain specified changes in laws and regulations, including a change in the capital rules resulting in TRUPS no longer being permitted to be treated as Tier 1 capital. This special event redemption price generally ranges from par to the greater of (i) the remaining principal balance of the TRUPS to be prepaid and (ii) the present value of all principal and interest payments remaining on such TRUPS, which is calculated in the manner set forth in the indenture governing the TRUPS. The make-whole calculation may be viewed as more expensive than the redemption price available at the expiration of the no-call period, thus causing issuers to contemplate offering to repurchase or exchange their outstanding TRUPS in negotiated transactions.

If there were an immediate elimination of TRUPS as an element of Tier 1 capital for Affected BHCs and Affected SLHCs, such elimination would constitute a so-called "regulatory capital event" under most, if not all, indentures governing these currently outstanding TRUPS, which would result in the Affected BHC and Affected SLHC issuers of such TRUPS immediately having the ability to redeem the TRUPS at the special event redemption price contained in their respective indentures whether or not the "no call" period included in such TRUPS issuances had expired. It is important to note, however, that most outstanding TRUPS would likely be unaffected by these provisions of the Conference Report, because their "no call" period would have expired by the time such provisions become effective. The requirement that TRUPS be excluded from Tier 1 capital would be phased in "incrementally" over the three-year phase-in period beginning on January 1, 2013, and although it is not yet clear what exactly this will mean, a regulatory capital event would not be triggered for most TRUPS unless all TRUPS were no longer permitted to be included as an element of Tier 1 capital; merely lowering the amount of TRUPS that could be included in Tier 1 capital would not trigger a regulatory capital event in most cases. Thus, it is possible that a regulatory capital event would not be triggered until the end of the three-year phase-in period (i.e., around January 1, 2016), by which time the "no call" provisions in most TRUPS that were issued prior to May 19, 2010, would have expired.

4. Potential Effects on Investors in TRUPS.

The Collins Amendment will also affect institutions that have invested in TRUPS. For TRUPS issued by Affected BHCs and Affected SLHCs that have unexpired "no call" provisions at the time any regulatory capital event occurs as a result of the legislation, such an occurrence of a regulatory capital event would trigger call provisions that could negatively impact the price of such TRUPS. Where the redemption price is economically too high, issuers may attempt to negotiate discounted payoffs of these securities.

In addition, with respect to TRUPS held in collateralized debt obligation (CDO) structures, CDO trustees and collateral managers face the threat of litigation regarding proposed discounted payoff transactions, where the litigants (such as senior and subordinated note holders, hedge counterparties and certain TRUPS issuers) believe agreements on discounted payoffs had been reached but are not being completed. As a result, any proposals to pay off TRUPS or effectuate capital replacement strategies for TRUPS held in CDO structures may require extra planning, time and effort, because the CDO trustees and collateral managers will want to structure any transaction to reduce any associated threat of litigation.

D. Much Left to Regulation.

Despite the statutory directives on regulatory capital adopted by the Conferees, federal banking regulators will retain significant discretion over the implementation of the scaled-back Collins Amendment. Issues not expressly covered by the proposed legislation and therefore reserved for regulations include, among others:

  • Though the general consensus is that TRUPS will continue to count fully as Tier 1 capital through December 31, 2012, and then be subject to an increasing level of a capital "haircut" during the three-year phase-in period, the details of the capital treatment of TRUPS during the phase-in period will be decided by future regulation and therefore remain unclear.
  • The Conference Report grandfathers Tier 1 capital treatment for TRUPS issued before May 19, 2010, by bank holding companies with consolidated assets of less than $15 billion as of December 31, 2009. Because the grandfathering provision is tied to asset size as of a specific date, it appears that bank holding companies may grow, organically or through acquisitions, beyond the $15 billion consolidated asset threshold in the future without Tier 1 capital treatment of their TRUPS being affected. Changes to regulatory capital regulations adopted by the Federal Reserve in response to the regulatory reform legislation are likely to shed additional light on this interpretation.
  • The Tier 1 capital treatment of TRUPS issued after May 19, 2010, by small bank holding companies that grow to a size at which they are no longer considered small bank holding companies also will be left to regulation.
  • Like so many other provisions in the regulatory reform bill, the true impact of the Collins Amendment will not be known until federal banking regulators adopt the regulations implementing the legislation. As always, "the devil is in the details."

E. Conclusion.

The softening of the Collins Amendment by the Conference Report is good news for the banking industry, particularly for community banks with asset sizes below the $15 billion threshold. Nevertheless, assuming the revised provision becomes part of the final regulatory reform legislation, Affected BHCs and Affected SLHCs will no longer be permitted to count TRUPS as an element of Tier 1 capital, subject to the phase-in period. These institutions will need to evaluate the resulting impact this change will have on their capital levels. Even if an Affected BHC or Affected SLHC would remain well-capitalized after excluding TRUPS as an element of Tier 1 capital, such exclusion would diminish any regulatory capital cushion of such holding company and could force many holding companies to consider capital replacement strategies and re-evaluate their business plans.

Because the Conference Report cannot be amended by the House or the Senate in their votes on the final regulatory reform bill, it is highly likely that the Collins Amendment, as scaled back by the Conferees, will become law. The Conference Report must now be passed by both the House and Senate before it can be sent to the President to be signed into law. The Conference Report may not be amended by either body. The House is currently expected to take up the Conference Report on June 29. The Senate is currently expected to take up and vote on passage of the Conference Report later the same week, but the death of Senator Byrd (D-WV) could delay this timetable.

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