United States: Trust Preferred/Tier 1 Capital and FRB Final Rule

The Federal Reserve Board (FRB) recently released¹ its final rule² continuing to allow the inclusion of qualifying trust preferred securities in tier 1 capital subject to certain qualitative requirements and quantitative limits that had been proposed in the FRB’s earlier notice of proposed rulemaking.³ The FRB’s proposed rule was the subject of 38 mostly supportive comments.⁴ Notably, only the comment letter from the Federal Deposit Insurance Corporation (FDIC) objected to the inclusion of trust preferred as tier 1 capital due to the accounting treatment as a liability under generally accepted accounting principles, and the FRB expressly declined to accept the FDIC’s arguments on this point.

For a summary of the FRB’s May 2004 rule proposal, please refer to the MBR&M client alert on this subject of May 10, 2004.⁵ The FRB’s final rule includes with some changes the quantitative limits previously proposed by the FRB and clarifies the qualitative requirements previously proposed. Among other things, the FRB:

• Requires the deduction (as previously proposed) of goodwill for purposes of measuring the tier 1 capital sublimit of 25%, but determined to allow the subtraction of any associated deferred tax liability from the amount deducted.
• Requires internationally active bank holding companies (defined for purposes of this rule as those with consolidated assets of greater than $250
• billion or on balance sheet foreign exposure of greater than $10 billion) to limit the aggregate amount of restricted core capital elements to 15% of
• the sum of all core capital elements.
• Extends to March 31, 2009 (from March 31, 2007 as previously proposed) the period for the required transition by bank holding companies to the new quantitative limits under the revised capital standards.
• Extends from May 31, 2004 (as previously proposed) to April 15, 2005, the grandfathering date for qualifying junior subordinated debt that contains nonconforming provisions.
• Rejected commentator requests to allow dividend step-ups in their tier 1 trust preferred securities and tier 2 subordinated debt.
• Agreed with commentator requests to eliminate the preexisting supervisory requirement that tier 1 trust preferred securities include call options.
• Reaffirmed the FRB’s policy that voting common stock should be the "dominant" form of a bank holding company’s tier 1 capital.

The rule takes effect on the first day of the first quarter following the expiration of 30 days after it is published in the Federal Register, although the FRB has stated that it will not object if a banking organization applies the rule beginning on the date the rule is published in the Federal Register. While some observers undoubtedly will not agree with all of the FRB’s actions and judgments that are reflected in the final capital rule, on balance the rule will bring helpful clarity and certainty to the trust preferred securities markets.

Please call Charles Horn (202.269.3219), Paul Forrester (312.701.7366) or your regular

MBR&M contact if you have any further questions about this matter.