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Category Archives: BHC Regulations

New Regulatory Framework for the Supervision of Bank Holding Companies and their Subsidiaries

By Michael Shumaker - Monday, July 5, 2010

The conference report of the Dodd-Frank Wall Street Reform and Consumer Protection Act creates a new regulatory framework for the supervision of financial holding companies and their non-bank subsidiaries, and provides new standards for interstate bank mergers, interstate bank acquisitions by bank holding companies, de novo branching for national and state banks, and charter selection and conversion (see Title VI).

Increasing Supervision of Holding Companies and Their Subsidiaries

Sections 604 and 605 of the conference report broaden the supervisory powers afforded to the Federal Reserve Board to supervise the activities of holding companies and their non-bank subsidiaries.  The conference report permits the Federal Reserve to review other supervisory materials – “reports and supervisory information” – provided to regulators by the holding company or any of its subsidiaries to get a better sense of the risk profile of non-depository subsidiaries of the holding company.  In addition, the Federal Reserve is permitted to commence examinations of the holding company and its subsidiaries, with a particular focus on prudential concerns such as the safety and soundness of the institution, the overall stability of the U.S. financial system, as well as a review of the compliance of the holding company and its subsidiaries with relevant provisions of federal law.

The conference report attempts to reduce the burden of additional regulatory examinations on financial institutions and regulators, with the Federal Reserve instructed to rely on reports from prior examinations by other federal or state regulators in order to get a preliminary picture of the condition of the holding company and its subsidiary.  The conference report further requires the Federal Reserve to coordinate its activities with the functional regulator of a subsidiary; for example, should the conference report be enacted, the Federal Reserve is required to consult with the OCC for its review of a national bank and to consult with the Securities Exchange Commission for its review of a securities or brokerage subsidiary.

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Capital Treatment of Trust Preferred Securities and TARP CPP Preferred Stock

By Barry Hester - Monday, June 28, 2010

After the dust settled on the work of the financial reform bill’s conference committee, Section 171 — the capital treatment provisions added by Senator Susan Collins (R-Maine) — grandfathers securities previously issued by small and mid-size bank and thrift holding companies and otherwise phases in the heightened standards.  In addition, the Federal Reserve’s small bank holding company policy statement (applicable to holding companies with less than $500 million in consolidated assets) is preserved.  Accordingly, the Dodd Frank Act will not impact small bank holding companies so long as they remain under $500 million in consolidated assets. Other provisions of the Act regulate systemic risk and direct the Fed to establish counter-cyclical capital requirements and to force holding companies to act as a “source of strength” for subsidiary banks.

The amended Section 171 avoids placing significant and untimely capital needs on community banks.  Although we do not expect further debate on this or any other provision of the Dodd Frank Act, the reconciled bill still needs to pass both houses of Congress and be signed by the President in order to become law.

The conference report does not modify the basic policy change proposed by Senator Collins — to subject holding companies to capital requirements at least as stringent as those applicable to banks.  As we have discussed, this shift would exclude trust preferred securities and TARP CPP Preferred Stock from holding company tier 1 capital totals.  The impact of this change cannot be understated since banks are already struggling to retire trust preferred obligations and to generally raise capital.  However, the conference committee has significantly softened the impact via grandfather provisions, blanket exemptions and transition periods.

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Refund Opportunity for Sub S Banks

By Frank Crisafi - Monday, May 10, 2010

7th Circuit Reverses Tax Court in Vainisi –

Subchapter S and Q Sub Banks Following Notice 97-5 with Respect to Expenses Relating to Tax Exempt Income
Should Consider Filing Refund Claims

On March 17, 2010, the U.S. Court of Appeals, Seventh Circuit, reversed the U.S. Tax Court’s decision in Vainisi v. Commissioner, 132 T.C. No. 1 (2009), which held that a sub-S corporation that is a bank (or in this case a bank holding company that owned a bank that had made a qualified S subsidiary or “Q-sub” election) is required, under the provisions of Section 291 of the Internal Revenue Code of 1986, as amended, (the “Code”), to increase the amount of its taxable income by 20-percent of the amount of the bank’s interest expense that is considered attributable to certain qualified tax exempt-obligations that are owned by the sub-S bank, despite the plain language of Code Section 1363(b)(4), which provides that “section 291 shall apply if the S corporation (or any predecessor) was a C corporation for any of the 3 immediately preceding taxable years.” The bank in the Vainisi case had been a Q-sub for longer than 3 years.

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TARP Recipients and Reporting on the Use of TARP Funds

By BT Atkinson - Wednesday, March 24, 2010

On January 12, 2009, the FDIC issued a Financial Institution Letter, FIL-1-2009, addressing the use of funding from Federal Financial Stability and Guaranty programs. FIL-1-2009 was brought to the attention of one of our financial institution clients that is a pubic reporting company and a TARP recipient, during the course of its annual examination.  Based on the guidance in the FIL, we advised the client to document and summarize the data that it had been monitoring on its use of TARP proceeds and also to include a fairly brief discussion summarizing that information in its Annual Report on Form 10-K.  This advice is intended to address the suggestion in the FIL that state nonmember banks “summarize such information in published annual reports and financial statements. Including such information in public reports will provide important information for shareholder and public evaluation of participation in these programs.”

If you are a smaller reporting company that has not finalized your 10-K, you should consider adding this disclosure, or perhaps including it elsewhere in public releases or reports.  Also, to the extent you have an examination scheduled in the coming weeks and months, be prepared for an inquiry concerning this FIL.

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Summary of Federal Reserve Proposed Compensation Guidance

By Jennifer Faucett - Monday, December 14, 2009

On October 22, 2009, the Federal Register published proposed guidance from the Federal Reserve for structuring incentive compensation arrangements at banking organizations.

There are several notable aspects of the proposed guidance. First, the Federal Reserve expects all banking organizations, not just entities participating in the Troubled Asset Relief Program, to review their incentive compensation arrangements in light of the guidance. Second, the guidance sets forth principles that banking organizations should follow and implement as part of their incentive compensation arrangements, but does not establish pay caps or other specific formulas for calculating incentive compensation. Third, the principles in the guidance apply to incentive compensation arrangements for executives, employees, and groups of employees who may expose the organization to material amounts of risk. They are not limited to compensation arrangements for executive officers or other highly compensated employees.

Principles of a Sound Incentive Compensation System

The Federal Reserve guidance is centered on three (3) main principles that should be followed when designing a sound incentive compensation system.

Principle #1: Balanced Risk-Taking Incentives

  • Incentive compensation arrangements should account for risks associated with employee’s activities when developing incentive compensation arrangements.

An incentive compensation arrangement should balance the risk and the reward associated with activities undertaken by the employee. This balance is achieved when incentive compensation paid to an employee accounts for the risks and the financial benefits associated with the employee’s activities. This may require banking organizations to reduce the amount of incentive compensation payable to an employee to account for the risks.

Example: Two employees generate the same amount of short-term profit, but the activities of one employee result in greater risk to the banking organization. Under a balanced incentive compensation arrangement, the employee whose activities result in a greater risk to the banking organization should receive less than the employee whose activities did not result in a greater risk to the banking organization.

  • Employees should understand how risk and risk outcomes are accounted for in their incentive compensation arrangements.

Banking organizations should communicate clearly to employees how an incentive compensation arrangement will account for risk and risk outcomes. The communication should include examples and should be tailored to the employees.
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SEC Extends Deadline for Sarbanes-Oxley 404(b) Compliance

By Amber Nash Hall - Monday, October 12, 2009

On October 2, 2009, the Securities and Exchange Commission (SEC) announced a nine-month deferral on Sarbanes-Oxley Act (SOX) Section 404(b) compliance for the smallest publicly reporting companies. Under the provisions of SOX 404, public companies and their independent auditors are each required to report on the effectiveness of company internal controls.  All publicly reporting companies are currently required to disclose a report on management’s assessment of internal controls; however, only reporting companies with a public float of $75 million or above are required to disclose an attestation report provided by an independent auditor.  The extension granted by the SEC will provide non-accelerated filers, those companies with a public float below $75 million, with a reprieve from independent auditor attestations until annual reports for fiscal years ending on or after June 15, 2010 are filed.  Although the SEC has not published the final rule providing for the extension, based on prior extensions, we believe the extended deadline only applies to independent auditor attestations.  Consequently, disclosure of management attestations on internal control continues to be required.

Prior to the October 2 announcement, the deadline for the independent auditor disclosure in annual reports for the smallest publicly reporting companies was fiscal years ending on or after December 15, 2009.  The previous extension, granted in January 2008, was put in place to allow the SEC’s Office of Economic Analysis to complete a study of whether additional guidance provided to company managers and auditors in 2007 was effective in reducing the costs of compliance.  This study was published recently, less than three months before the December 15 deadline, and, as a result, the SEC determined that additional time was appropriate and reasonable so the smallest publicly reporting companies and their auditors could better plan for the required attestation.

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FDIC Issues Final Statement of Policy on Investor Qualifications for Failed Bank Acquisitions

By BT Atkinson - Wednesday, September 23, 2009

Background

On July 2, 2009, the Board of Directors of the Federal Deposit Insurance Corporation (“FDIC”) issued for public comment a proposed Statement of Policy that sets forth the qualifications for private equity investors in failed bank acquisitions (the “Proposed Policy”).  The FDIC established a 30-day comment period and sought public comment on nine topics:

  • definition of private equity investor and scope of the policy;
  • permissibility of “silo” structures;
  • capital requirements;
  • applicability of the source of strength doctrine;
  • imposition of cross-guarantee liability;
  • restrictions on bidders from bank secrecy jurisdictions;
  • post-investment holding period;
  • possible limitations on 10% investors in failed institutions; and
  • length of restriction period.

On August 26, 2009, the FDIC issued its Final Statement of Policy on Qualifications for Failed Bank Acquisitions (the “Final Policy”).   The FDIC notes that the policy statement is just that—a statement of policy and not a statutory provision imposing civil or criminal penalties and that the requirements it imposes on investors only apply to investors that agree to its terms.

In response to 61 comment letters from a broad variety of interests, in the Final Policy the FDIC reduced the proposed capital requirements, removed the proposed “source of strength” requirement, and increased the ownership threshold for cross-guarantee liability.  These changes are intended to make the failed bank acquisition opportunity more attractive for private equity investors, while retaining many of the other elements of the Proposed Policy that address the FDIC’s apparent concerns about such investors.

The Final Policy is relevant only to bidders for failed financial institutions.  Investors seeking to acquire control of banks that have not failed should refer to the Bank Holding Company Act and the relevant regulations and policy statements issued by the Federal Reserve Board including, but not limited to, the policy statement issued by the Federal Reserve Board on September 22, 2008 that eased certain limitations on private equity investments in banks and bank holding companies.  This policy statement is summarized in our prior client alert on private equity investments generally.    Investors seeking to acquire control of federal savings institutions that have not failed should refer to the Home Owners’ Loan Act and relevant regulations issued by the Office of Thrift Supervision.  These existing holding company statutes and regulations are not replaced or substituted by the Final Policy.  The Final Policy merely adds additional limitations and requirements in the context of acquiring failed financial institutions.

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Reminder Regarding Inclusion of Trust Preferred Securities in Tier 1 Capital

By Lauren Brown - Friday, August 21, 2009

Although the trust preferred securities (“TPS”) market has been quiet (or non-existent) for the past few years, many bank holding companies have issued TPS in the past to take advantage of the hybrid capital treatment afforded to TPS by the Federal Reserve.  In 2005, the Federal Reserve revised its rules permitting the inclusion of a limited amount of TPS in the Tier 1 capital to provide stricter quantitative limits. Under the 2005 rule, which became effective on March 31, 2009, bank holding companies may include TPS in Tier 1 capital in an amount up to 25% of all core capital elements less goodwill and any associated deferred tax liability. Core capital elements include common shareholders’ equity, noncumulative perpetual preferred stock (including preferred stock issued pursuant to the Troubled Asset Relief Program (TARP)), and minority interests directly issued by a consolidated U.S. depository institution or foreign bank subsidiary. Any TPS issued in excess of this limit may be included in Tier 2 capital.

Prior to March 31, 2009, bank holding companies were permitted to calculate the limit for TPS without deducting goodwill and associated deferred tax liability from Tier 1 capital. The regulators are now taking note that some bank holding companies with outstanding TPS have not revised their Tier 1 calculations to comply with the newly-effective rule. If your bank has a holding company with outstanding TPS, be sure that you are limiting the TPS component of Tier 1 capital to 25% of core capital elements less goodwill and any associated deferred tax liability.

In addition, in the current economic environment, many bank holding companies are experiencing deterioration in capital. When the core capital elements of Tier 1 capital decline, the amount of TPS that may be included in Tier 1 capital also declines, thereby further reducing a bank holding company’s leverage ratio. When calculating capital ratios, bank holding companies must remember to re-evaluate the inclusion of TPS in Tier 1 capital as capital declines.

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Obama Proposes Comprehensive Regulatory Reform

By Rob Klingler - Wednesday, June 17, 2009

On June 17, 2009, the Obama administration publicly announced its vision of regulatory reform.  Among the key points for community banks and thrifts:

  • Combine the Office of the Comptroller of the Currency (OCC) and Office of Thrift Supervision (OTS) into a new federal agency, the National Bank Supervisor, which would remain an office of the Treasury Department.  The National Bank Supervisor would have all the powers of the OCC and the OTS.  The Federal Reserve and FDIC would retain their respective roles with respect to state banks.
  • Eliminate the federal thrift charter, subject to “reasonable” transition arrangements.
  • Eliminate restrictions on interstate branching by national and state banks.  States would not be allowed to prevent de novo branching into the state, or to impose a minimum age requirement of in-state banks that can be acquired by an out-of-state banking firm.
  • Thrift holding companies and Industrial Loan Company (ILC) holding companies would both be required to become Bank Holding Companies supervised by the Federal Reserve.
  • Create a new federal Consumer Financial Protection Agency (CFPA).  The CFPA is proposed to have sole authority to promulgate and interpret regulations under existing consumer financial services and fair lending statutes, including TILA, HOEPA, RESPA, CRA, and HMDA.  The CFPA is also proposed to assume from the federal prudential regulators all responsibilities for the supervision, examination and enforcement of consumer financial protection regulations.
  • States would have the authority to adopt and enforce stricter laws, and federally chartered institutions would be subject to nondiscriminatory state consumer protection and civil rights laws to the same extent as other financial institutions.

As a reminder, we are the very beginning of regulatory reform; the final reforms are undoubtedly not going to be exactly as laid out in the President’s current proposal.

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New Supervisory Guidance on BHC’s Dividends, Redemptions and Repurchases

By Rob Klingler - Wednesday, February 25, 2009

On February 24, 2009, the Federal Reserve published a Supervisory Letter regarding the ability of bank holding companies to declare dividends and to redeem or repurchase equity securities.  The Supervisory Letter is generally consistent with prior guidance, although places greater emphasis on discussions with the regulators prior to dividend declarations and redemption or repurchase decisions even when not explicitly required by the regulations.  Although consultation with the Federal Reserve in these situations is optional, the guidance makes clear that the failure to consult with the Federal Reserve “could result in a supervisory finding that the organization is operating in an unsafe and unsound manner.”

The Federal Reserve provides that the principles discussed in the letter are applicable to all bank holding companies, but are especially relevant for bank holding companies that are experiencing financial difficulties and/or receiving TARP Capital.  To that end, the Supervisory Letter specifically addresses the Federal Reserve’s supervisory considerations for TARP Capital participants.

TARP Capital

In addition to the general guidance provided by the Supervisory Letter and the explicit restrictions on dividends, repurchases and redemptions contained in the TARP Capital documents, the Supervisory Letter also provides guidance on how the supervisory staff will analyze TARP Capital recipients.  The guidance provides that TARP recipients should “consider and communicate reasonably in advance” to supervisory staff  how the bank holding company’s proposed dividends, capital redemptions, and capital repurchases are “consistent with the requirements applicable to its receipt of capital under the program and its ability to redeem, within a reasonable period of time and with Federal Reserve consent, its outstanding capital issuance under the program.”  The Federal Reserve’s guidance specifically calls for the redemption of the TARP Capital “as soon as reasonably feasible and appropriate.”

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