Death Knell for Trust Preferred - But A Reprieve for Some

Among the many immediate changes to come with President Obama's signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") on July 21 is its impact on the ability of bank holding companies to include trust preferred securities ("TruPS") in their tier 1 regulatory capital.

Until the TruPS market collapsed in the recent financial crisis, TruPS had been increasingly relied on by bank holding companies. According to the Federal Reserve Bank of Philadelphia, as of December 31, 2008, almost 1,400 bank holding companies had approximately $148.8 billion TruPS outstanding, up from 110 bank holding companies with $31.0 billion outstanding in 1999. TruPS were treated as tier 1 regulatory capital for holding companies under Federal Reserve Bank regulations, but were treated as debt under tax law, thus making payments on TruPS tax deductible. Proceeds could be contributed to bank subsidiaries as capital or held at the holding company level.

Section 171 of the Dodd-Frank Act, the so-called Collins Amendment (the "Collins Amendment"), eliminates the favorable capital treatment for TruPS by requiring that bank holding companies' leverage and risk-based capital requirements be at least as stringent as those applicable to insured banks.

The Collins Amendment sets a floor — risk-based and leverage capital requirements cannot be less than the risk-based and leverage capital requirements established by the federal regulatory agencies under the prompt corrective action regulations or quantitatively lower than the risk-based and leverage capital requirements in force on July 21, 2010. As a result, TrUPS, which are not counted as tier 1 regulatory capital for banks, can no longer serve as tier 1 regulatory capital for bank holding companies.

Importantly, though, TruPS outstanding as of May 19, 2010 that were issued by bank holding companies with total consolidated assets less than $15 billion or by mutual holding companies are grandfathered from the impact of the Collins Amendment and will continue to count as tier 1 capital for risk-based and leverage capital requirements.

Also, the new risk-based and leverage capital requirements do not apply to:

• Debt or equity instruments issued pursuant to the Emergency Economic Stabilization Act of 2008 (i.e., TARP funds) prior to October 4, 2010;
• Any federal home loan bank; or
• Any small bank holding company that is subject to the Small Bank Holding Company Policy Statement of the Board of Governors, as in effect on May 18, 2010, applicable to holding companies with less than $500 million in assets.

The Collins Amendment will otherwise be phased in as follows:

• For banks with $15 billion or more total consolidated assets, the new risk-based and leverage capital requirements will be phased in over three years, with the phase-in period beginning January 1, 2013.
• Thrift holding companies and other depositary institution holding companies that were not previously supervised by the Federal Reserve Board will be exempt from the new risk-based and leverage capital requirements until July 21, 2015.
• Subsidiaries of foreign banking organizations that have relied on Supervision and Regulation letter SR-01-1 issued by the Board of Governors, will be exempt from the new risk-based and leverage capital requirements until July 21, 2015.

Note that, even though a bank holding company may be grandfathered, the passage of the Collins Amendment could qualify as a "capital treatment event" or similar event under particular TruPS instruments. As a result, the issuer may be entitled to certain redemption rights. Issuers of TruPS should check the governing instruments to determine the impact of the Collins Amendment on their outstanding TruPS.

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