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FRB: Trust Preferred Securities and the Definition of Capital

ABA Contact: Paul Smith, (202) 663-5331
                         Gwen Ritter, (202) 663-4986
Published: 69 Federal Register 28851; May 19, 2004
Comments Due: July 11, 2004
Disposition: Filed

Background

ABA Supported the FRB's proposal, but urged the FRB to not require deducting of goodwill in calculating the amount of allowable trust preferred securities. However, if the FRB does adopt that restriction, ABA recommended a 5-year transition rather than a 3-year transition period.

Proposal

In 1996, the FRB approved the inclusion in BHCs' tier 1 capital of trust preferred securities (TPS).[1] Because TPS 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 FRB proposes permitting BHCs to continue to include outstanding and prospective issuances of TPS in their tier 1 capital, subject to stricter quantitative limits, which would apply to a broader range of capital instruments issued by BHCs.[2] 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, 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.

The FRB proposes that the limit for the aggregate amount of a BHC's cumulative perpetual preferred stock, TPS, 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. The Board is lowering the current 25 percent limit, which currently is determined on a basis that does not deduct goodwill. 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, but amounts of qualifying TPS 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.

Finally, 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 1998 Basel agreement concerning innovative capital instruments.  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.

[1] 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 TPS 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. TPS 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.

[2] In late December 2003, FASB issued a revised version of FIN 46 (FIN 46R) that generally concluded that such trusts must be deconsolidated in financial statements under GAAP. The result is that, under GAAP, TPS 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, a BHC no longer may reflect on its balance sheet the TPS issued out of the SPE, but rather must reflect the deeply subordinated note the BHC issued to the deconsolidated SPE.

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