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Home > Bank Resources > Bank Resources Publications > SRC Insights > 2005 > Second Quarter

SRC Insights: Second Quarter 2005

Federal Reserve Board's Final Rule on Trust Preferred Securities

by Eddy Hsiao, Supervising Examiner

The Federal Reserve Board issued a press release on March 1, 2005 announcing the adoption of the highly anticipated final ruling on trust preferred securities (TPS).1 The new rule, which became effective on April 11, 2005, amended the risk-based capital standards for bank holding companies. As expected, the Board will continue to allow tier 1 capital treatment for TPS. However, stricter quantitative limits and qualitative standards have been imposed. Bank holding companies (BHCs) have a five-year transition period, ending March 31, 2009, to adopt the quantitative limits.

The key differences between the new rule and the old rule are summarized in the table below. In addition, a chart reflecting the regulatory report line items on the FR Y-9C, FR Y-9LP, and FR Y-11 is included as a reference.2

The Federal Reserve Bank of Philadelphia will monitor each Third District BHC’s TPS level using the stricter limits during the transition period. BHCs need to have adequate plans in place to address any potential significant impact to their regulatory capital positions once the new limits are applied.

Summary of Key Changes

Key Changes Old Rule New Rule

Notification Requirement

Issuers should consult with the Fed on the capital impact before issuance of TPS

Issuers must consult with the Fed on the capital implication before issuance

Dividends Deferral Notification Period

No specific minimum notification period

No sooner than 15 business days prior to the payment day

Call Option for Tier 1 Capital Qualification

One of the key features for tier 1 capital qualification

Call option requirement has been eliminated

Core Capital Elements (CCE)

1)common stock
2) noncumulative perpetual
3)cumulative perpetual
4) minority interest

Same as old rule, but minority interest is further divided into three classes and qualifying cumulative preferred stock & others are categorized into restricted core capital elements*

Deduction of Goodwill from the Calculation of the 25% or 15% of CCE

Not deducted

Goodwill, net of the related deferred tax liabilities, must be deducted for the calculation

15% Limit for Internationally-Active Companies

Suggested or encouraged but not required for internationally-active companies

Mandatory for BHCs that are internationally-active (e.g., BHCs required to follow Basel II)

Sublimits

Amount in excess of the 25% limit is aggregated with other allowable tier 2 capital, which is limited to 100% of tier 1 capital

Excess amount is aggregated with term subordinated debt, limited-life preferred stock, and Class C minority interest , which is further limited to 50% of tier 1 capital

Amortization or Discount in the Last Five Years Before Maturity

No amortization; the allowable portion of TPS is included in tier 1 capital over the life of the instrument

In the last five years, TPS is moved from tier 1 to tier 2 capital and subject to 20% annual amortization


* Restricted core capital elements, which are limited to 25% of the sum of all core capital elements, include qualifying cumulative perpetual preferred stock, Class B minority interest, Class C minority Interest, and qualifying TPS.

Regulatory Report Line Items Affected by TPS Transactions

Transaction Y-9LP Y-11 Y9-C

BHC Invests in Common Stock of the Trust

PI-A-PartII-3 (Payment for investment in subsidiary)

PC-A-2a (Investment in nonbank subsidiary)

PC-5 (Investment in subsidiaries)

IS-A-3 ( Sale of common stock)

BS-18a (Stock)

HC-8 ( Investment in unconsolidated subsidiary)

HC-R-42 (All other assets)

Trust Issues TPS

NA

IS-A-3 ( Sale of perpetual preferred stock)

BS-18a (Stock)

NA

BHC Issues Debt to the Trust

PI-A-PartIII-5 (Proceeds from issuance of long-term debt)

PC-18b ( Balance due to nonbank subsidiary)

PC-B-5b (Borrowings by the parent from nonbank)

PC-B-16 (Note payable to subsidiary that issued TPS)

BS-9 & BS-M8a

(Balance due from related institution/BHC)

HC-19b (Payable to unconsolidated trust issuing TPS)

HC-R-6b (Qualifying TPS)

HC-R-16 (Other tier 2 capital components), for the excessive amount

BHC Pays/Accrues Interest

PI-2d (Other expenses)

PI-M4 (Interest expense paid to special purpose subsidiaries that issued TPS)

IS-1b (Interest income from related organization)

BS-9 (Balance due from related organization)

BS-M8a (Balance due from BHC)

HI, 2e

(Other interest expense)

Trust Pays Dividends

NA

IS-A-4 (Dividend declared)

BS-14 (Other liabilities) if not yet paid

BS-M11a Expenses accrued and unpaid

NA

If you have questions regarding the capital treatment or the reporting of TPS, please contact Vince Poppa, Supervising Examiner at (215) 574-6492 or Eddy Hsiao, Supervising Examiner at (215) 574-3772.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.