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FED ER AL RESERVE BANK OF NEW YORK I”Circular No. 7674 I July 24,1975 PROPOSED AMENDMENTS TO REGULATIONS D AND Q Issuance of Subordinated Debt To All Member Banks, and Others Concerned, in the Second Federal Reserve District: Following is the text of a statement issued July 2 by the Board of Governors of the Federal Reserve System: The Board of Governors of the Federal Reserve System today issued for comment guidelines to be applied by the Board in evaluating requests for approval of new subordinated debt issues proposed by State member banks as an addition to the bank’s capital structure. The guidelines were issued in connection with proposed amendments, being issued at the same time, to Regulation D (Reserve Requirements) and Regulation Q (Interest on Deposits) with respect to issuance of subordinated debt. The regulatory revisions would apply to all member banks. Comment on the Board’s proposals is invited through August 29, 1975. The regulatory amendments were proposed as a means of providing greater flexibility in the requirements member banks must meet when they issue subordinated notes and debentures for the purpose of adding to the bank’s capital structure. The proposed amendments to Regulations D and Q would: 1. Replace the present requirement that an obligation of a member bank have an original maturity of at least seven years with a provision for average maturity of seven years under certain conditions. —As an alternative, the Board is considering whether the seven-year minimum maturity should be retained for unamortized issues, and a ten-year maturity be set for amortized issues, with repayment beginning anytime, provided that all scheduled repayments are made annually and none is less than that of the year before. For amortized issues, this could result in a five-year average maturity. 2. Permit a bank’s obligations, under certain circumstances to be issued in denominations of less than the present minimum of $500, with prior Board approval. 3. Require the approval of the appropriate Federal bank regulatory agency for redemption of a debt issued prior to maturity, including any repayment in connection with acceleration of maturity in the event of default. If adopted, the amendments—and guidelines—would apply to applications for new debt issues acted upon after the effective date of the amendments. The guidelines—applying to State member banks—proposed in connection with the Board’s consideration of the proposed regulatory amendments, would be used by the Board in deciding whether to approve bank plans for new issues of subordinated notes and debentures as an addition to the bank’s capital structure. The Comptroller of the Currency has advised the Board that he is considering use of the same guidelines in evaluating applications from national banks for approval of supplemental debt issues. Application of these proposed criteria is intended among other things, to promote the accumulation by State member banks issuing new debt of an adequate cushion of equity capital, to assure that a bank’s earnings are adequate to service additional debt, to protect against undue concentration of maturing debt in any one year, and to prevent the inclusion of terms in such issues that could be regarded as being in conflict with the public interest. In issuing the guidelines for comment, the Board stressed that they are not to be regarded—and would not be administered—as a rigid set of rules in addition to those set forth in Regulations D and Q. Rather, they would be administered flexibly, taking into account the circumstances of particular banks. These circumstances might include the urgency of the bank’s need for additional equity capital, the availability of new equity, the prospective growth of the bank, the impact of unusual income and expenses on recent earnings, and the relative strength of nonbank affiliates or subsidiaries. The Board provided a set of numerical examples to assist banks in evaluating the proposed guidelines. The proposed guidelines are: 1. Debt to equity ratio: The total amount of outstanding subordinated capital notes and debentures of a bank, including the debt proposed to be issued, should not exceed 50 per cent of the bank’s equity capital base. Banks with significant asset or management problems generally would not be presumed to be entitled to go this high. For this test, a bank’s equity capital base includes capital stock, surplus, undivided profits, capital reserves and all reserves for losses on loans or securities. 2. Earnings coverage test: In general, average adjusted net income of a State member bank during the preceding five years should exceed total fixed charges by a multiple of at least three. Before tax net income would include securities gains or losses, exclude extraordinary charges and credits, and would be adjusted where necessary to reflect actual loan loss experience in lieu of other provision for loan loss. Total fixed charges include annual interest charges before taxes on all existing debt as well as the new debt proposed to be issued, including all outstanding mortgage debt and capital notes and debentures, plus one-third of lease charges. This guideline sets forth further requirements for the debt of a bank that is a subsidiary of a holding company. 3. Retained earnings test: Annual pro forma amortization on all subordinated notes and debentures, including the issue proposed, should not exceed 50 per cent of a State member bank’s average retained earnings over the preceding five years. Retained earnings include net income after taxes minus dividends declared on common and preferred stocks. Pro forma amortization would be ascertained by dividing the original amount of an issue by the number of years from the date of issue to maturity. The Board said that considerable discretion would be used in the administration of this test, to the end that the particular circumstances of individual banks were given due weight. 4. Accumulation o f equity over the life o f the debt: Over the lifetime of the debt, the issuing bank would be expected to replace a debt issue with equity, in equal annual amounts, by the time of maturity. 5. Debt retirement: Where the amount to be repaid on a debt issue at maturity, together with scheduled repayments in that year on other debt of the bank would exceed 15 per cent of the bank’s capital base at the date of a new issue, the bank shall provide for reducing the amount of debt outstanding at maturity by a sinking fund or other debt retirement arrangement, or have the right to call such an obligation for redemption at least five years before maturity. 6. Interbank transactions: In general, the Board does not intend to approve a capital note or debenture issued by a State member bank directly or indirectly to another bank, except in compelling circumstances. 7. Covenants in conflict with the public interest: No contract governing the issuance of a subordinated capital note or debenture by a State member bank shall include any covenants, restrictions or other terms that are determined by the Board to be inconsistent with the public interest. Printed on the following pages is the text of the proposed amendments to Regulations D and Q. Comments thereon should be submitted by August 29, 1975, and may be sent to our Bank Regulations Department. Alfred Hayes, President. Board of Governors of the Federal Reserve System P R O P O S E D A M E N D M E N T S T O R E G U L A T IO N S D & G ISSUANCE OF SU BO RDINATED D EB T FEDERAL RESERVE SYSTEM [ 12 CFR Part 204 and 217 ] [R eg. D a n d R eg. Q ] RESERVES OF MEMBER BANKS AND INTEREST ON DEPOSITS Definition of Deposits— Subordinated Notes Th e B o ard of G overnors proposes to am end R egu lation s D (12 C F R 204) and Q (12 C F R 217) to provide gre ater flexi bility to the requirem ents fo r exem ption from deposit treatm en t under both regu lation s where a m em ber bank issu es ce r tain su bord in ated notes an d debentures fo r th e purpose of add in g to the b an k ’s ca p ita l stru ctu re. T h ese am endm ents would (1) m odify the presen t require m ent th a t an obligation have an original m atu rity of seven y ears or m ore to p er m it an obligation (or an issue of obli gatio n s) to have an average m atu rity of seven y ears or m ore under certain con ditio n s; (2) m odify the presen t require m ent th a t an obligation m u st be in an am ou n t of a t lea st $500 to perm it excep tions to be m ade by the ap p rop riate F ed eral banking agency to the $500 m in i m um denom ination (a) to fa cilita te sale o f convertible debt where, in order to sa tisfy preem ptive righ ts of sh areh old ers, the bank would be required to issue a convertible obligation of less th an $500 fa c e am o u n t; (b) to m ain tain a ra ta b le un it offering to holders of preem ptive righ ts where a su bord in ated debt ob liga tion is issu ed exclusively a s a p a r t of a unit including sh are s of stock which are su b je ct to such preem ptive rig h ts; (c) to sa tisfy sh areh old ers’ ratab le claim s where an obligation is issued wholly or p artia lly in exchan ge fo r sh ares of vot in g stock or asse ts p u rsu an t to a plan of m erger, consolidation, reorganization, qr other tran sactio n where the issu er will acquire either a m a jo rity of such sh a re s of voting stock or all or su b sta n tially all of the a sse ts of the entity whose a sse ts are being acquired ; an d (3) re quire the issuing b an k to receive the app roval of the app rop riate F ed eral b an k in g agency of any redem ption prior to m atu rity or any paym en t p u rsu an t to acceleration of m atu rity in event of de fa u lt. U nder the proposal, the B o ard would retain the option to deny a re quest th a t it waive the am oun t lim ita tion in those in stan ces in which it deter m in es th a t reason able altern atives a re available to the p arty seeking the waiver. I f adopted, the am endm en ts would a p ply to app lication s for new debt issues acted upon a fte r the effective date of the am endm en ts an d would not affect the sta tu s of any ou tstan d in g issues. In all cases, the app rop riate F ed eral b a n k ing agency is the Com ptroller of the C urrency for n atio n al b an k s and the B o ard of G overnors for S ta te m em ber banks. S in ce 1966, th e B o ard h a s exem pted from reserve requirem ents o f R egu lation D an d in terest ra te lim its o f R egu lation Q certain su b ord in ated debt issu es of m em ber b an k s by providing a n excep tion to the definition of deposits under R egu lation s D an d Q. U pon review of the existin g regulation, th e B o ard believes th at, in certain circum stances, gre ater flexibility should be availab le to perm it m em ber ban k s to receive app rov al from the ap p rop riate F ed eral b an k in g agen cy for su b ord in ated note an d debenture is su es th a t m ay not conform to the e x ist ing regulatory requirem ents. auth ority to ta k e action to stop u n safe an d u nsoun d ban k in g p ractices (12 U .S.C. 1818b), a n d related provisions of the law, the B o ard proposes to am en d R egu lation D (12 C F R 204) an d R e g u la tion Q (12 C F R 217) a s follow s: 1. Section 204.1 would be am ended by revising p a ra g ra p h (f) (3) a s follow s: U nder the proposal, regular debt am ortizatio n or retirem ent could begin a t any tim e so long a s the w eighted a v erage m atu rity of the obligation or issu e of obligation s would be a t le a st seven y ears an d so long a s once th e reduction of prin cipal begins, all scheduled re p ay m ents o f p rin cipal sh all be m ad e a n n ually in an am oun t no less th a n the previous scheduled paym ent. As an a lte r native, the B o ard is considering w hether the seven-year m inim um m atu rity should be retain ed fo r unam ortized issues an d a ten -y ear m inim um m atu rity be se t for am ortized issues, with repaym en t begin ning a t any tim e a fte r the d ate of issu e provided th a t once repaym ent of p rin ci p al begins, all scheduled repaym ents sh all be m ade ann ually in an am ou n t no less th an the prior scheduled repaym ent. F o r the purp oses of th is P a rt, the term “ deposits” also includes a m em ber b a n k ’s liability on any prom issory note, a c know ledgem ent of advan ce, due bill, b an k er’s acceptan ce, or sim ila r obligation (w ritten or o ral) th a t is issu ed or u n dertaken by a m em ber bank a s a m ean s of obtaining fu n d s to be used in its b a n k ing business, except any such obligation th a t: Th e proposed exception to the $500 m inim um denom ination would fa cilita te sa le of convertible debt where, in order to sa tisfy preem ptive righ ts of stock holders, a n issu in g b an k would be re quired to issue obligation s in face am ou n ts less th an $500. An exception to the $500 m inim um denom ination is also proposed where, in order to m ain tain a ra ta b le unit offering to holders of p re em ptive righ ts in the case of a su b ord i n ated debt obligation issued exclusively as p art of a unit which includes sh a re s of stock which are su b je ct to such p re em ptive rights, an issu in g bank would be required to issu e obligation s in fa c e am ou n ts less th a n $500. T h e th ird p ro posed exception to the $500 m inim um d e n om ination requirem ent would app ly where an issu ing bank would be required to issue obligation s in fa c e am ou n ts less th an $500 in order to sa tisfy sh areh o ld e rs’ ratab le claim s in the case of an ob ligation which is issued wholly or p a r tially in exchan ge fo r sh a re s of voting stock or assets p u rsu an t to a p lan of m erger, consolidation, reorgan ization, or other tran sactio n in which th e issu er will acquire either a m a jo rity of such sh a re of voting stock or all or su b stan tially all the a sse ts of an o th er entity. T h e provisions requiring prior app roval of redem ption an d paym en t p u rsu an t to acceleration of m atu rity are m ean t to perm it the ap p ro p riate F ed eral banking agency to assess the im pact of such p ay m ent on the cap ital stru ctu re of the bank. P u rsu an t to its auth ority under sec tion 19 of the F ed eral R eserve A ct (12 U .S.C. 461) to define the term s used in th a t section, its auth ority to exam in e m em ber b anks u nder section 9 of th e F ed eral R eserve Act (12 U .S.C. 325), its 3 § 2 0 4 .1 * D e fin itio n s. * * * * (f) Deposits as including certain promissory notes and other obligations. * * * * * (3) (i) B e a rs on its face, in b old -face type, the follow ing: “ T h is obligation is not a deposit an d is not insured by the F ed eral D eposit In su ran ce C orp oratio n ” ; is su bordinated to the claim s of deposi tors, is unsecured, an d is ineligible a s collateral for a loan by the issu in g bank an d also expressly sta te s sa id provisions on its fa c e ; h a s a m atu rity of a t le a st seven y ears, or, in the ca se of a n o b liga tion or issue th a t provides fo r scheduled repaym ents of prin cipal, h a s a n average m a tu rity * of a t le a st seven y e a rs* an d provides th a t once repaym ent of p rin ci p al begins, all scheduled repaym en ts sh all be m ade ann u ally in an am ou n t no less th an the prior scheduled re p ay m ent; is issu ed su b je ct to a requirem ent th a t no repaym en t (oth er th a n an a p proved regularly scheduled rep ay m en t), including but not lim ited to a p ay m en t p u rsu an t to acceleration of m atu rity , m ay be m ade w ithout the prio r w ritten approval of th e ap p ro p riate F ed eral b anking a g e n cy ; T is in a n am ou n t o f a t lea st $500 except th a t th e ap p ro p riate F ed eral b ank ing agency m ay approve the issu an ce of an obligation th a t is less than $500 if the obligation is convertible into com m on stock and, in order to sa tis fy the preem ptive righ ts of sh areh olders, the issu ing b an k would be required to is sue obligation s in a n am ou n t of less th an $500, or if the obligation is issued exclu sively a s p a r t of a unit including sh are s 8 T h e “ a v e ra g e m a tu r ity ” o f a n o b lig a tio n o r is s \ie r e p a y a b l e i n s c h e d u l e d p e r io d ic p a y m e n ts s h a ll b e t h e tim e -w e ig h te d a v e ra g e o f a ll s u c h s c h e d u le d p a y m e n ts . * T h e B o a r d is a ls o c o n s id e r in g w h e t h e r th e 7 -y e a r m in im u m m a tu r ity s h o u ld b e r e ta in e d fo r u n a m o r tiz e d iss u e s a n d a 1 0 -y e a r m in im u m m a tu r ity b e s e t fo r a m o rtiz e d is s u e s w ith re p a y m e n t b e g in n in g a t a n y tim e a f t e r t h e d a te o f is s u e p r o v id e d t h a t , one© r e p a y m e n t o f p r in c i p a l b e g in s , a ll s c h e d u le d re p a y m e n ts s h a ll b e m a d e a n n u a lly in a n a m o u n t n o le s s t h a n t h e p r io r s c h e d u le d re p a y m e n t. 1F o r th e p u rp o se s o f th is p a rt, th e “ a p p r o p r i a t e F e d e r a l b a n k i n g a g e n c y ” Is th ® C o m p tro lle r o f t h e C u rre n c y In t h e c a se o f a n a tio n a l b a n k a n d th e B o a rd o f G o v e r n o rs in th e c a se o f a S ta te m e m b e r b a n k . a t lea st seven y e a rs* an d provides th a t once repaym en t of prin cipal begins, all scheduled repaym en ts sh all be m ade a n nually in a n am ount no less th an the prior scheduled repaym en t; is issued su b je c t to a requirem ent th a t no repaym en t (other th an a n approved regularly sch ed uled re p a y m e n t), including but not lim ited to a paym en t p u rsu an t to a cc elera tion of m atu rity , m ay be m ade w ithout the prior w ritten app roval of the a p p ro p riate F ed eral banking a g en cy ;7 is in an am oun t of a t le a st $500 except th a t the app rop riate F ed eral banking agency m ay approve the issu an ce of a n obligation th a t is less th an $500 if the obligation is convertible into com m on stock and, in order to sa tisfy the preem ptive righ ts of sh areh olders, the issu in g bank would be required to issu e obligation s in an am oun t of less th an $500, or if the ob liga tion is issued exclusively a s p a rt of a unit including sh ares of stock which are su b je ct to such preem ptive righ ts and, in order to m ain tain a ratab le u n it offering to holders of preem ptive righ ts, the issu ing bank would be required to issue obli gatio n s in an am oun t of less th a n $500, or where, in the case of an obligation issued wholly or p artially in exchan ge fo r sh ares of voting stock or a sse ts p u rsu an t to a * * * * * p lan of m erger, consolidation, re o rg a 2. Section 217.1 of R egu lation Q would n ization, or other tran sactio n where the be am ended by revising the introductory issu er will acquire eith er a m a jo rity of p arag ra p h in p a ra g ra p h (f) & (f) (3) as such sh ares of voting stock or all or su b stan tially all of the a sse ts of the en tity follow s; whose a sse ts are being acquired, an d in § 2 1 7 .1 D e fin itio n s order to sa tisfy sh areh o ld e rs’ ratab le * * * * * claim s, the issu in g b an k would be re (f) Deposits as including certain quired to issue obligation s in a n am ou n t promissory notes and other obligations. of less th an $500; an d h a s been approved F o r the purposes o f th is P a rt, the term by the ap p ro p riate F ed era l b an k in g “ d epo sits” also includes a m em ber agency a s an add ition to the ca p ita l b a n k ’s liability on an y p rom is stru ctu re of the issu in g ban k ; or (ii) sory note, acknow ledgm ent of advance, m eets all of the requirem ents in the p re due bill, or sim ilar obligation (w ritten ceding clau se except m atu rity an d with o r o ral) th a t is issued or u n d ertak en by resp ect to which the ap p ro p riate F ed eral a m em ber ban k principally as a m eans of b anking agency h a s determ ined th a t ex obtain in g fun ds to be used in its b a n k igen t circum stan ces require the issu an ce in g business, except any such obligation of such obligation w ithout re gard to the t h a t: provisions of this p a r t; or (iii) w as issued * * * * * or publicly offered before Ju n e 30, 1970, (3) (i) B e a rs on its face, in bold-face with an original m atu rity of m ore th an type, the follow ing: “ T h is obligation is two years. * * * * * n ot a deposit an d is n ot insured by the F ed eral D eposit In su ran ce C or In connection with its consideration of po ratio n ” ; is su bord in ated to the claim s the regulatory am endm en ts proposed of depositors, is unsecured, an d is in herein, the B o ard also h a s determ ined eligible a s co llateral for a loan by th a t S ta te m em ber b anks sh ould be p ro the issu in g b an k an d also expressly vided with gu id an ce a s to the criteria to sta te s sa id provisions on its fa c e ; h a s a be applied by the B o ard in ev alu atin g m atu rity of a t le a st seven years, or, in requ ests for app roval of new issu es of th e case of an obligation or issue th a t su b ord in ated n otes an d debentures “ a s provides fo r scheduled repaym ents of a n addition to the b a n k ’s ca p ita l prin cipal, h a s an average m a tu r ity 0 of stru ctu re .” In actin g upon requ ests from S ta te • T h e “ a v e ra g e m a t u r it y ” o f a n o b lig a tio n m em ber b anks fo r app rov al of proposed o r Issu e r e p a y a b le in s c h e d u le d p e rio d ic p a y issu es of su b ord in ated n otes a n d d e m e n ts sh a U b e th e tim e -w e ig h te d a v e ra g e o r bentures, th e B o ard tak e s in to accoun t a ll s u c h s c h e d u le d p a y m e n ts . variou s asp ects of the a p p lic an t’s fin a n • T h e B o a r d is a ls o c o n s id e r in g w h e th e r th e 7 -y e a r m in im u m m a tu r ity s h o u ld b e cial condition an d its prospective c a r e ta in e d fo r u n a m o r tiz e d issu e s a n d a 10p acity to service the proposed debt in y e a r m in im u m m a tu r ity b e s e t fo r a m o rtiz e d of stock which are su b ject to such p re em ptive righ ts and, in order to m ain tain a ratab le unit offering to holders of p re em ptive righ ts, the issu in g bank would be required to issu e obligations in an am ou n t of less th an $500, or where, in the case of an obligation issued wholly or p artially in exchan ge fo r sh a res of voting stock or a sse ts p u rsu an t to a p lan of m erger, consolidation, reorganization, or other tran sactio n where the issu er will acquire either a m ajo rity of such sh ares o f voting stock or all or su b stan tially all of the a sse ts of the entity whose a sse ts a re being acquired, an d in order to s a t isfy sh areh old ers’ rata b le claim s, the is su in g bank would be required to issue ob ligation s in an am oun t of less th an $500; an d h a s been approved by the ap p rop ri a te F ed eral banking agency a s an ad d i tion to th e cap ital stru ctu re of the issu in g b an k ; or (ii) m eets all of the require m ents in the preceding clau se except m a tu rity an d with respect to which the a p p ro p riate F ed eral bank ing agency h a s determ ined th a t exigent circum stances require the issu an ce of such obligation w ithout regard to the provisions of th is p a r t; or (iii) w as issued or publicly o f fered before Ju n e 30, 1970, with an o rig in al m atu rity of m ore th an two y ea rs; or Issu e s, w ith re p a y m e n t b e g in n in g a t a n y tim e a f t e r t h e d a te o f is s u e p r o v id e d t h a t o n c e r e p a y m e n t o f p r in c ip a l b e g in s , a ll s c h e d u le d r e p a y m e n ts s h a ll b e m a d e a n n u a lly In a n a m o u n t n o le s s t h a n t h e p r io r s c h e d u le d r e p a y m e n t. ; F o r th e p u rp o se s o f th is p r o p ria te F e d e ra l b a n k in g C o m p tro lle r o f th e C u rre n c y n a tio n a l b a n k a n d th e B o a rd th e case o f a S ta te m e m b e r p a rt, th e “a p a g e n c y ” is t h e in th e ca se o f a o f G o v e rn o rs in bank. view of the b a n k ’s earn in gs history and c a p ita l stru ctu re. A pplication of these criteria is intended also to prom ote the accu m u lation by d eb t-issu in g b an k s of an ad equ ate cushion of equity cap ital, p rotect a g a in st undue co n cen tration s of m atu rin g debt in any one year, an d p re vent the inclusion of term s in su ch is sues th a t could be regard ed a s in con flict with the public interest. In addition, it is stre ssed th a t the guidelines se t fo rth below, a s applied by the B o ard a re not intended to provide or be adm in istered in a m an n er resu ltin g in a rigid set of requirem ents in add ition to th o se set fo rth in R egu lation s D an d Q. R ath e r, they are to be adm in istered flexibly, ta k ing into accou n t the sp ecial circu m stan ces of p articu la r ap p lican ts. (T hese m igh t include the urgency of th e b a n k ’s need fo r ad d ition al c a p ita l an d the a c cessibility of ad d ition al equity, the prospective grow th of the bank, the im p a c t of u n u su al incom e an d expen se d e velopm ents on recent earn in gs, an d the relative stren gth of earn in gs of n onbank affiliates or su b sid iaries.) B y p ublication of th ese guidelines which the B o ard intends to u se in its ev alu ation of ap p lication s fo r su ch e x em ption, the B o ard also invites com m ents from the public on these c rite ria a t the sam e tim e a s com m ents a re re ceived on the regu latory am en d m en ts proposed herein. T h e C om ptroller of the C urrency h a s advised the B o ard th a t h e is con sid erin g use of the sam e guidelines in ev alu atin g app lication s from n atio n al b an k s fo r a p proval o f su b ord in ated debt issu es p u rsu a n t to 12 C F R 14.5. G u id e l i n e - C r it e r ia f o r E v a l u a t in g D e b t I s s u e s a s A d d it io n t o a S t a t e M e m b e r B a n k ’s C a p i t a l S t r u c t u r e 1. Maximum ratio of debt to equity. T h e to tal am ou n t of su b ord in ated n otes an d debentures o u tstan d in g, including the debt proposed to be issued, sh ou ld not exceed 50 p er cen t of a b a n k ’s equity ca p ita l b ase. However, b an k s w ith sig n ifi ca n t a ss e t or m an agem en t problem s ge n erally would n ot be presum ed to be en titled to issu e debt ca p ita l up to the 50 per cent ceiling. A b a n k ’s equity ca p ita l base, fo r p urposes of th is test, is con sidered to include c a p ita l stock, su rp lu s, undivided profits, ca p ita l reserves, a n d all reserves fo r losses on lo an s a n d secu rities. 2. Earnings coverage test. T h e to ta l of fixed ch arges a s a re su lt of an y issu e of su b ord in ated n otes or deben tures sh ould not exceed 33 x/z Per cent of a S t a te m em ber b a n k ’s a v e rage n et incom e before ta x e s an d before fixed ch arges over the preceding five y ears. T h erefore, in gen eral, av erage ad ju ste d n et incom e should exceed to ta l fixed ch a rg es by a m u ltiple of a t le a st three. F o r p urp oses of th is test, b efo re-ta x n et incom e would include secu rities gain s or losses, exclude e x t r a ord in ary ch arges an d credits, a n d would be a d ju ste d w here n ecessary to reflect a c tu a l loan lo ss experience ra th e r th a n other “ provision fo r lo an lo ss.” T o ta l fixed ch arges include a n n u al in terest ch arges before tax es on all existin g debt p rogram aim ed a t replacin g sh ortera s well a s the new debt proposed to be term debt with lon ger-term debt. issued. F ix e d ch arges on existin g debt 4. Accumulation of equity over the life would include in terest on all ou tstan d in g of the debt. E a c h S ta te m em ber bank m o rtgage debt a n d su bord in ated n otes issu ing su b ord in ated notes an d deben a n d debentures, plus on e-third of lease tures would be expected to accum u late co n tracts. equity, in equal an n u al in stallm en ts In app ly in g this test to a bank th a t is from retain ed earnings, in a n am ount a su b sid iary o f a holding com pany which sufficient to in crease equity ca p ita l by the show s a net deficit on its nonbank op er fu ll am oun t of o u tstan d in g an d newly atio n s. the am ou n t of such deficit, c a l issued debt over the lifetim e of the debt. cu lated on a b efo re-tax b asis, would be In effect, th is requirem ent would provide su b stra c te d from n et incom e a s derived for replacem en t of each debt issu e with fro m the p a r a g ra p h above. T o determ ine equity by m aturity. the am oun t, if any, of net deficit on n on 5. Provision for debt retirement. W here b an k operation s, n et incom e before tax es the residu al am oun t of a proposed new of the b an k would be su b stracted from debt issue to be repaid a t m atu rity , to con solid ated n et incom e before ta x es of geth er with scheduled repaym en ts in the holding com pany. F or m ultibank th a t y ear on other debt-type cap ital and holding com panies, the nonbank n et defi m o rtgage indebtedness, would exceed 15 cit generally would be allo cated am ong per cent of the b a n k ’s presen t cap ital su b sid iary b an k s in proportion to their base, the bank sh all either provide for n et income. O rdinarily, the ad ju stm en t reducing the am oun t of debt o u tsta n d would be b ased on d a ta fo r the m ost re ing a t m atu rity by a sinking fun d or cen t year, but, in som e cases, a n average other debt-retirem ent arran gem en t or (covering not m ore th an the m ost recent h ave the righ t to call such obligation s five y ears) would be m ore represen tative fo r redem ption a t lea st five y ears before of prospective earn in gs experience. T h is m atu rity . ad ju stm en t, in effect, would reduce the 6. Approval of interbank debt transac allow able am ou n t of new fixed in terest tions. In general, the B o ard does not in exp en se which could be asu m ed by any tend to approve a su bordinated note or b an k whose nonbank affiliates, including debenture issued by a S ta te m em ber the p are n t holding com pany, incur an b an k directly or indirectly (throu gh a ag g re g a te n et deficit. T h e offset a g a in st holding com pany or otherw ise) to the b a n k ’s earn in gs recognizes the p o s anoth er bank a s a n addition to the issu sibility th a t the p aren t m igh t have to ing b a n k ’s cap ital stru ctu re unless sp e rely on dividends from the b an k in cifically authorized as such an addition order to cover a nonbank deficit, thereby by the B o ard of G overnors upon a p re s redu cin g the b a n k ’s ability to m ain tain en tation and finding of com pelling cir or build its equity cap ital. cu m stan ces. Su ch tran sactio n s provide 3. Retained earnings test. A nnual prono add ition al cap ital protection for the forma am ortizatio n on all su b ord in ated b an k in g system a s a whole an d ord in ar n otes an d debentures, including the p ro ily will be discouraged. posed debt issue, should not exceed 50 7. Covenants in conflict with the public p er cent of a S t a te m em ber b a n k ’s aver interest. No indenture or other co n tract ag e retain ed earn in gs over the preceding covering the issu an ce of a su bordinated five y ears. R e tain ed earn in gs u nder this note or debenture by a S ta te m em ber criterio n a re considered to include net b ank sh all include any covenants, re incom e a fte r ta x e s m inus dividends de striction s, or other term s which are d e clare d on com m on an d preferred stock. term ined by the B o ard to be inconsisten t F o r each issu e of subord in ated debt, in with the public interest. E xam ples of cluding a proposed new issue, an n u al pro such term s are those regarded a s im fo rm a am ortization would be calcu lated p airin g the ability of the bank to com ply by dividing the original am oun t of the with sta tu to ry or regulatory requ ire issu e by the num ber of years from d ate m ents regard in g disposition of a sse ts or of issu e to m atu rity . T o tal pro form a incurrence of add ition al debt, lim iting am o rtizatio n would be the su m of an n u al the ability of the B o ard or the ch arterin g pro fo rm a am ortizatio n fo r all o u tsta n d auth ority to tak e any n ecessary action in g an d proposed issues. to resolve a problem bank situ ation , u n C onsid erable discretion would be used duly in terferin g with the ability of the in th e ad m in istration o f th is test. In bank to conduct n orm al b anking op era som e circum stances, ban k s which h ave tions, or im posing term s an d conditions issu ed add ition al sh ares of equity c a p i on the bank th a t are unduly h arsh or ta l du rin g the five-year period fo r which onerous. average retain ed earn in gs are calcu lated E x a m p l e s o f P r o p o s e d G u i d e l i n e C r i t e r i a would receive credit fo r these new issu es 1 , 2 AND 3 a s if they h ad been p a r t of retain ed ea rn The fo llo w in g c a lc u la tio n s d e m o n s tra te ings. In addition, som e ban k s which have t h e a p p l i c a t i o n o f T e s t s 1 , 2 , a n d 3 o f t h e o u tstan d in g su b sta n tia l am ou n ts of re l g u i d e l l n e - c r i t e r i a f o r e v a l u a t i n g d e b t I s s u e s . atively sh o rt-term su bord in ated debt T h e d a t a u s e d I n t h e c a l c u l a t i o n s a r e f o r a prio r to the issu an ce of these guidelines h y p o t h e t i c a l b a n k , w h o l l y - o w n e d b y a o n e would be gran ted sp ecial consideration b a n k h o l d i n g c o m p a n y . W h e r e a p p l i c a b l e , I te m s t h a t a r e r e p o r te d in t h e C o n s o lid a te d In the ap p lication of the retain ed earn R e p o r t o f I n o o m e a n d C o n s o l i d a t e d R e p o r t in gs te st to proposed new issues, so long o f C o n d i t i o n a r e d e s i g n a t e d b y t h e i r l i n e a s the new issu es were p a rt of a specified n u m b e r s o n t h e r e q u i r e d r e p o r t s . F o r e x 5 a m p le , [R I-A 1 0 ] r e f e r s t o n e t in c o m e a s r e p o r te d in S e c tio n A , l in e 10 o f t h e R e p o r t o f In c o m e . T o ta l a s se ts , a s r e p o r te d o n lin e 14 o f t h e R e p o r t o f C o n d i ti o n w o u ld b e i d e n t i f i e d a s [ R C - 1 4 ] . A ll d o l l a r a m o u n t s a r e In th o u s a n d s o f d o lla r s . ( B a n k s t h a t a re r e q u i r e d t o f ile a C o n s o lid a te d R e p o r t o f C o n d itio n in c lu d in g fo re ig n a n d d o m e s tic s u b s id ia rie s w o u ld u s e a m o u n ts s h o w n in t h a t re p o rt, r a th e r th a n th o s e s h o w n In th e C o n s o lid a te d R e p o r t o f C o n d itio n in c lu d in g o n ly d o m e s tic s u b s id ia r ie s .) T h e h y p o th e tic a l b a n k p re s e n tly h a s o u t s ta n d i n g tw o is s u e s o f s u b o r d in a te d d e b t: ( 1 ) $ 8 ,0 0 0 — 8 p e r c e n t S u b o r d i n a t e d d e b e n t u r e s , d u e S e p t. 15, 1987. ( 2 ) $ 7 ,0 0 0 — 1 0 p e r c e n t C a p i t a l n o t e s , d u e J u n e 30, 1980. I t p r o p o s e s , o n J a n u a r y 1, 1 9 7 5 , t o i s s u e $ 9 m illio n o f a d d itio n a l s u b o rd in a te d d e b t o n te r m s d e s c rib e d in th e illu s tr a tio n s t h a t f o llo w . TEST : i M A X IM U M R A T IO OF DEBT TO E Q U IT Y Guideline. T h e to ta l a m o u n t o f s u b o rd i n a te d n o te s a n d d e b e n tu re s o u ts ta n d in g , in c lu d in g s u b o rd in a te d d e b t p ro p o se d to b e iss u e d , s h o u ld n o t e x c e e d 50 p e r c e n t o f a b a n k ’s e q u i t y c a p i t a l b a s e . Calculations 1. S u b o r d i n a t e d n o t e s a n d d e b e n tu r e s o u ts ta n d in g , D ec. 31, 1974 ( R C - 3 4 ) ___________________________ $ 1 5 , 0 0 0 2. E q u ity c a p ita l, to ta l, D ec . 31, 1 9 7 4 ( R C - 3 5 ) ______________________ 5 0 ,0 0 0 3. T o ta l re s e rv e s o n lo a n s a n d s e c u ritie s , D ec. 31, 1974 ( R C -3 3 )_ 4. E q u ity c a p ita l b a s e ( lin e 2 p lu s l i n e 3 ) ______________________________ 5. C u r r e n t r a t i o o f s u b o r d i n a te d d e b t to e q u ity c a p ita l b a s e (lin e 1 d i v i d e d b y l i n e 4 ) _______________ 6. A m o u n t o f p r o p o s e d n e w i s s u e . 7. S u b o r d in a te d d e b t, in c lu d in g p r o p o s e d n e w iss u e ( lin e 1 p lu s l i n e 6 ) ......................................... .................... 8. R a t io o f s u b o r d i n a t e d d e b t, i n c lu d in g p r o p o s e d n e w is s u e , t o e q u ity c a p ita l b a s e (lin e 7 d i v i d e d b y l i n e 4 ) _________________ 1 0 ,0 0 0 6 0 ,0 0 0 .2 5 9, 000 2 4 ,0 0 0 . 40 Conclusion. S in c e th e r a tio o f s u b o rd in a te d d e b t, in c lu d in g th e p ro p o se d n e w is s u e (lin e 8 ) , d o e s n o t e x c e e d 50 p e r c e n t , t e s t 1 Is m e t . TEST 2 : Guideline. ju ste d net E A R N IN G S C OVER AGE T E S T In g e n e ra l, a v e ra g e a n n u a l a d In co m e over th e past 5 y e a rs s h o u l d e x c e e d t o t a l f ix e d c h a r g e s , i n c l u d i n g th e a n n u a l in te re s t c h a rg e o n th e p ro p o se d new iss u e , by a m u ltip le of at le a s t 3. Calculations 9. I n c o m e b e fo r e in c o m e ta x e s a n d s e c u r itie s g a in s o r lo ss e s , 1 9 7 0 -7 4 a v e ra g e ( R I - A 3 ) ____________________ $ 9 , 7 4 0 10. N e t s e c u r i ti e s g a in s o r lo s s e s , b e fo re ta x (R I-A 6 e ff e c t, 1 9 7 0 -7 4 a v e ra g e ( c o l . 1 ) ) _ ______ ____________ 290 11. P r o v is i o n f o r l o a n lo s s e s , 1 9 7 0 -7 4 a v e ra g e ( R I - A 2 1 ) 1___________________ 230 12. N e t c h a rg e o ffs o n lo a n s , 1 9 7 0 -7 4 a v e ra g e (R I-D 6 (c o l. 1 p lu s 2) m in u s R I - D 3 (c o l. 1 p l u s 2 ) ) 1 as t h e for loan losses In l i n e s 11 an d 12. 1 B a n k s u s in g a c tu a l n e t c h a rg e o ffs am ount of th e ir p ro v is io n n e e d m a k e n o e n tr ie s 260 13. N o n b a n k d e f ic it o f h o ld in g c o m p a n y , If a n y , 1974 * ( e n te r o n ly if n e g a t i v e n u m b e r ) --------------------------14. A v e ra g e a d ju s te d n e t In c o m e b e fo re in c o m e ta x e s , 1 9 7 0 -7 4 ( lin e 9 p l u s l i n e 1 0 p l u s l i n e 11 m i n u s l i n e 1 2 p l u s l i n e 1 3 ) ------------------------15. I n t e r e s t and on s u b o rd in a te d n o te s 1 ,3 4 0 10. I n te r e s t o n m o rtg a g e d e b t, 1 9 7 4 . 660 of le a s e 1974 9 ,2 0 0 (R I-A 2 f)_ 1 7 . y3 d e b e n tu r e s , (8 0 0 ) p a y m e n t* on bank p re m ise s a n d e q u ip m e n t, 1 9 7 4 -. 1 ,0 0 0 18. F ix e d c h a r g e s o n p r e s e n t o b l ig a tio n s (lin e 15 p l u s l in e 16 p l u s (lin e 1 7 ) ............................................................. 3 .0 0 0 22. A v e ra g e a d ju s te d n e t in c o m e , b e f o r e fix e d c h a r g e s o n p r e s e n t o b lig a tio n s a n d in te r e s t c h a rg e o n p r o p o s e d n e w is s u e ( li n e 19 p l u s l i n e 2 1 ) --------------------------------------1 3 , 0 1 0 23. F ix e d c h a rg e s o n p r e s e n t o b lig a tio n s a n d in te r e s t c h a rg e o n p r o p o s e d n e w is s u e (lin e 18 p lu s l i n e 2 1 ) ______ ____________ ___________ 3 ,8 1 0 24. E a r n in g s c o v e ra g e r a tio , in c lu d in g in te r e s t c h a rg e o n p ro p o se d n e w is s u e ( lin e 22 d iv id e d b y l i n e 2 3 ) ______________________________ 3 .4 1 fo re f ix e d c h a rg e s on C u rre n t e a rn in g s c o v e ra g e T E S T 3 : R E T A IN E D E A R N IN G S T E S T 21. A nnual posed in te re s t c h a rg e new p e rc e n t iss u e annual on (assu m es 12, 2 0 0 ra tio ( l i n e 19 d i v i d e d b y l i n e 1 8 ) --------- 4 .0 7 p ro a 9 r a t e ) _____________ 810 A v erag e a n n u a l r e ta in e d e a r n in g s o v e r th e p a s t 5 y e a rs s h o u ld e x c ee d th e a n n u a l p r o f o rm a a m o r tiz a tio n o n a ll s u b o r d in a te d n o te s a n d d e b e n tu re s , in c lu d in g t h e p ro p o se d n e w iss u e , b y a m u ltip le o f a t l e a s t 2. T w o i l l u s t r a t i o n s a r e p r o v id e d b e lo w . T h e f ir s t e x a m p le (lin e s 3 0 a th r o u g h 3 2 a ) a s s u m e s a f in a l m a t u r i t y o f 10 y e a rs . T h e s e c o n d e x a m p le (lin e s 3 0 b t h r o u g h 3 2 b ) a s s u m e s a f in a l m a t u r it y o f 20 y e a rs . 3 T h is a d j u s t m e n t t o n e t in c o m e is m a d e o n ly i f t h e b a n k is a s u b s id ia r y o f a h o ld in g c o m p a n y t h a t I n c u r s a n e t d e fic it in its n o n bank o p e r a t i o n s . T h e n o n b a n k d e f i c i t , c a l c u la t e d o n a b e f o r e - ta x b a s is , is t h e n e g a tiv e d iffe re n c e o b ta in e d b y s u b tr a c tin g th e c o n s o lid a te d n e t in c o m e o f t h e b a n k f ro m th e c o n s o lid a te d net in c o m e o f th e h o ld in g c o m p a n y , b o th a d ju s te d in th e m a n n e r il l u s t r a t e d i n l i n e s 9 t h r o u g h 12 o f t h i s e x a m p le . O rd in a rily , th e a d ju s tm e n t fo r a n o n bank d e f i c i t w o u l d b e b a s e d o n d a t a f o r t h e m o s t r e c e n t y e a r, b u t in so m e c ases, a n a v e r a g e c o v e rin g n o m o re t h a n th e m o s t r e c e n t 5 y e a rs w o u ld b e m o re r e p r e s e n ta tiv e o f p r o s p e c tiv e e a rn in g s e x p e rie n c e . Calculations 1. 64 U nder t u r i t y o f 10 y e a rs f o r t h e b a n k ’s r e t a i n e d ( lin e 3 2 a ) w o u ld n o t q u ire m e n t o f te s t 3. a n a s s u m e d fin a l m a th e p ro p o se d n e w iss u e , e a r n i n g s r a t i o o f 1 .6 4 m e e t th e m in im u m r e Calculations A s s u m in g a 2 0 - y e a r f in a l o n p ro p o se d n e w iss u e : m a tu rity 30b. P ro fo rm a a m o r tiz a tio n o f p r o p o s e d n e w is s u e ( lin e 6 d iv id e d by a fin a l m a tu rity of 20 y e a rs) ______________________________ $450 31b. T o ta l p ro fo rm a a m o r tiz a tio n , in c lu d in g p ro p o s e d n e w iss u e ( l i n e 2 8 p l u s l i n e 3 0 b ) __________ 1 ,9 8 3 32b. R e ta in e d e a rn in g s r a tio , in c lu d in g p ro p o se d n e w is s u e (lin e 27 d i v i d e d b y l i n e 3 1 b ) _____________ 2 .0 2 26. C a s h d iv id e n d s d e c la r e d o n c o m m o n a n d p r e f e r r e d s to c k , 1 9 7 0 74 a v e ra g e (R I-B 3 a p lu s R I B 3 b ) __________________________________ 4 ,0 0 0 27. A v e ra g e a n n u a l r e ta in e d e a r n in g s, 1 9 7 0 -7 4 ( lin e 25 m in u s lin e 26) ......................— ..............- ......................... 4 ,0 0 0 28. D e s c r ip tio n o f issu e 8 percent subordinated debentures_____________________ 10]percent capital notes.______________________________ Total............................................................................. .... P ro fo rm a a m o rtiz a tio n o f e x is t i n g d e b t ( t o t a l o f c o l. 4 b e lo w ) _ (2) A m o u n t of o rig in a l iss u e (3) 1, 533 (4) Y e a r s fro m d a te o f issu e t o d a te of m a tu r ity $8,000 7,000 P r o fo rm a a m o r tiz a tio n (col. 2 d iv id e b y coL 3) 15 7 $533 1,000 15,000 ............................. 1,533 39. Current retained earnings ratio 30a. Pro form a am ortization of pro(lln e 27 divided by lin e 2 8 ) ____ 2. 61 posed n ew issu e (lin e 0 d ivided ------------------------ by a final m a tu rity o f 10 A ssu m in g a 10-year final m a tu rity years) _________________________ $900 o n proposed new Issu e : — --------- 6 Conclusion. 20 of 25. N e t in c o m e , 1 9 7 0 -7 4 a v e ra g e (R I-A 1 0 ) ............. ..........................................$ 8 , 0 0 0 (1) 3 2a. R e ta in e d e a rn in g s r a tio , in c lu d in g p ro p o s e d n e w is s u e ( lin e 2 7 d i v i d e d b y l i n e 3 1 a ) __________ Guideline. p resen t o b l i g a t i o n s ( l i n e 14 p l u s l i n e 1 8 ) 20. 2 ,4 3 3 Conclusion. Conclusion. T h e e a r n i n g s c o v e r a g e r a t i o , in c lu d in g t h e in te r e s t c h a rg e o n t h e p r o p o s e d n e w i s s u e ( l i n e 2 4 ) e q u a l s 3 .4 1 a n d th e r e fo r e m e e ts th e r e q u ir e m e n ts o f t e s t 2. 19. A v e ra g e a d ju s t e d n e t in c o m e b e 3 1 a. T o ta l p ro fo rm a a m o r tiz a tio n , in c lu d in g p ro p o se d n e w is s u e l i n e 3 8 p l u s l i n e 3 0 a ) ------------------ T h e lo n g e r fin a l m a t u r i t y o f y e a rs re s u lts in a re ta in e d e a rn in g s r a tio 2 .0 2 ( l i n e 3 2 b ) w h i c h p a s s e s t h e m i n i m u m a c c e p ta b le r a tio fo r t e s t 3. To aid in the co n sid eration of the p ro posed am endm en ts to R egu latio n s D and Q by the B o ard an d to fa c ilita te the evalu ation of the a p p ro p riate n e ss and effectiveness of the gu id elin e-criteria set fo rth herein, in terested p ersons a re re quested to su bm it relevan t d a ta , views, or argu m en ts. Any such m ateria l sh ou ld be sub m itted in w riting to the Secretary , B o ard o f G overn ors of the F ed eral R e serve Sy stem , W ashin gton, D.C. 20551, to be received n ot la te r th a n A ugu st 29, 1975. S u ch m a te ria l will be m ad e a v a il able fo r inspection an d copying upon request, except a s provided in § 261.6(a) of the B o a r d ’s rules re gard in g a v a il ab ility of in form ation . B y order of the B o a rd of G overnors, J u ly 1,1975. [seal] T h e o d o r e E . A l l is o n , Secretary of the Board. [FR D oc.75-18178 F iled 7-14 -7 5 ;8 :4 5 am ]