Many Trust Preferred Securities Will Cease to Qualify for Tier 1 Capital Under the Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)

Trust preferred securities have long played a controversial role as a component of tier 1 regulatory capital for depository institutions and their holding companies.¹

During the financial regulatory reform debate in the United States Congress, there was discussion of the appropriateness of trust preferred securities as a limited component of tier 1 capital in the aftermath of the credit crisis.² Trust preferred securities are a popular form of regulatory capital, having steadily grown in both number of issuers and in outstanding amount since first permitted as qualifying tier 1 capital. As of December 31, 2008, there were approximately 1400 bank holding companies (BHCs) that had issued over $148 billion of trust preferred securities (compared with 110 BHCs with $31 billion of trust preferred securities in 1999).³

The so-called “Collins Amendment” was proposed in the United States Senate to eliminate trust preferred securities as tier 1 regulatory capital for depository institution holding companies and nonbank financial companies that are supervised by the Federal Reserve Board. However, this provision was subsequently modified in the Conference Committee on the reform legislation to apply only to depository institution holding companies that (i) have more than $15 billion of total consolidated assets as of December 31, 2009 or (ii) were not mutual holding companies on May 19, 2010.⁴ This provision is currently included as Section 171 of the Dodd-Frank Act, which is printed in the June 29, 2010, Conference Report on H.R. 4173 (Conference Report).⁵

Affected depository institution holding companies have a three-year phase-out period, beginning January 1, 2013, to replace the related trust preferred securities (see Section 171(b)(4)(B) of the Dodd-Frank Act) with qualifying tier 1 regulatory capital. Similarly, most US bank holding company subsidiaries of foreign banking organizations that have issued trust preferred securities would have a five-year transition period.

Notably, for trust preferred securities that were issued on or after May 19, 2010, there is no phase-out period and the disqualification would become effective on May 19, 2010.⁶

Accordingly, depository institution holding companies that had more than $15 billion in total consolidated assets on December 31, 2009, will no longer be able to include trust preferred securities as tier 1 regulatory capital, and would be obliged to replace their outstanding pre-May 19, 2010, trust preferred securities with qualifying tier 1 regulatory capital during the phase-out period. Depository institution holding companies with less than $15 billion in total assets could continue to count their pre-May 19, 2010, trust preferred securities as tier 1 regulatory capital, but could not issue new capital-qualifying trust preferred securities.

Notably, qualifying “small bank holding companies,” as defined by existing Federal Reserve Board supervisory policy statements (in general, bank holding companies with consolidated assets of less than $500 million),⁷ would be exempt from Section 171 of the Dodd-Frank Act and could continue to issue capital-qualifying trust preferred securities.

Of course, governing instruments for existing trust preferred securities will dictate which related trust preferred securities can be called and when.

Affected sponsors of trust preferred securities should carefully review the governing instruments for the requirements of a call and, in cases where the no-call period may not yet have fully run, carefully review the definition of “Capital Treatment Event” (or similar term) used for trust preferred securities. This is because there are different definitions used in the capital markets and the differences may be material to which specific issue of trust preferred securities is callable for adverse changes in regulatory capital treatment and when.

For more information about the issues raised in this Legal Update, please contact J. Paul Forrester or Jeffrey P. Taft.

Learn more about our Banking & Finance, Corporate & Securities and Structured Finance practices.

---

Footnotes:

1. See our earlier Client Alert dated March 2, 2005 regarding the Federal Reserve Bank’s rule that imposed qualitative requirements and quantitative limits for trust preferred in order to qualify as tier 1 capital. As noted in the alert, the sole objector to the proposed rule was the FDIC.
2. An objective examination of trust preferred in the financial crisis by the Philadelphia Federal Reserve bank is available at: http://www.philadelphiafed.org/bank-resources/publications/src-insights/2009/first-quarter/q1si4_09.cfm
3. Ibid.
4. This provision is currently included as Section 171 of the Dodd-Frank conference report and is available at: http://financialservices.house.gov/Key_Issues/Financial_Regulatory_Reform/Conference_report_final_3.pdf.
5. The Conference Report is available at: http://financialservices.house.gov/Key_Issues/Financial_Regulatory_Reform/Conference_report_final_3.pdf.
6. See Section 171(b)(4)(A) of the Dodd-Frank conference report.
7. See Federal Reserve Board, “Small Bank Holding Policy Statement,” 12 C.F.R. Part 225, Appendix C (2010).