FED PROPOSES NEW RULES FOR TOPrS qualification as regulatory capital

Northwestern Financial Review, Dec 15-Dec 31, 2004 by Midness, Sjur

The Bank & Finance Group at Fredrikson & Byron represents a wide spectrum of clients in the financial services and commercial areas including banks, bank holding companies, insurance companies and clients with banking affiliations. Our attorneys have substantial knowledge in state and federal banking regulation, enforcement actions, tax law, bank mergers and acquisitions, bankruptcy, commercial paper, secured financing, real estate and UCC matters.

For more information and contacts within the Bank & Finance Group, see page 4. An electronic version of this newsletter is available on the Internet. You can access our home page at: www.fredlaw.com. Bank Focus is edited by Jane C. Ball, Senior Paralegal.

On May 6, 2004, the Board of Governors of the Federal Reserve System (the Board) proposed new rules that would regulate how bank holding companies with consolidated assets of $150,000,000 or more employ trust originated preferred securities (TOPrS). The biggest impact of the proposed rules is to solidify the qualification of TOPrS as part of regulatory capital.

TOPrS enjoy a number of attractive qualities, including: regulatory capital qualification, deductibility of interest expense, nondilutive effect on ownership (and if employed effectively, on ROE), decreasing transaction costs and placement fees because of increased efficiency and competition, and competitive rates.

The proposed rules include a three-year transition period that would make them applicable beginning at the end of the first quarter of 2007. Currently proposed transactions will have to reflect compliance with the new rules for periods after March 31, 2007.

NETTING OF GOODWILL

The proposed rules potentially decrease from 25% the proportion of Tier 1 capital that TOPrS may comprise. The proposed rules require that the 25% calculation be made not against all of the bank's Tier 1 capital, but against Tier 1 capital minus the holding company's consolidated goodwill. This change will not affect some institutions at all. For the more acquisitive, it could be restrictive.

MANDATORY CONSULTATION AND QUALITATIVE STANDARDS

The proposed rules require that each holding company consult with the Board before it issues TOPrS. The proposed rules also describe characteristics that TOPrS must have, e.g., they must include a minimum of 20 consecutive quarters of dividend deferral and must include a call option for the bank holding company at no later than 10 years. For most companies, this will not be of concern as pool arrangers will address these issues in the structure of their deals.

PHASE OUT

The proposed rules provide that during the last five years of the life of the TOPrS, they will not count at all toward regulatory capital.

BHCS UNDER 8150,000,000

The regulatory capital treatment for TOPrS of so-called small bank holding companies is not specifically addressed by the proposed rules. The operating assumption of most practitioners is that an amount of subordinated debt associated with TOPrS up to 25% of a small bank holding company's GAAP total stockholders equity (net of goodwill) would be considered neither debt nor equity for purposes of calculating the debt-to-equity ratio under the "Small Bank Holding Company Policy Statement." Another operating assumption is that a similar three-year transition period will apply. We'll have to wait for another Board pronouncement or a collection of experiences until we'll know.

SJUR MIDNESS

Bank & Finance Group

612.492.7175

smidness@fredlaw.com