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FEDERAL RESERVE BAINK OF MEW YORK [ Circular N o. 9 9 5 6 1 N ovem ber 2 1 , 1985 J CA PITAL M AINTENANCE Proposal on T reatm ent of Perpetual D ebt as P rim ary C apital To A ll State M em ber B a n ks and B ank H olding C om panies in the S eco n d F ederal R eserve D istrict: Following is the text of a statement issued by the Board of Governors of the Federal Reserve System: The Federal Reserve Board has published for comment a proposal that would define as primary capital perpetual debt securities issued by State member banks and bank holding companies. Comment is requested by January 17, 1986. To qualify as primary capital, such perpetual debt securities would be required to meet specific criteria that are intended to make perpetual debt the functional equivalent, for capital purposes, of per petual preferred stock. In addition, comment is requested on whether a limit should be imposed on the combined amount of mandatory convertible instruments, perpetual preferred stock, and perpetual debt that could qualify as primary capital. The Board proposed a limit of 33A percent of primary capital, exclusive of such instruments, in order to ensure that common stockholders’ equity remains the dominant component of primary capital. Because the treatment of perpetual debt as primary capital would allow banking institutions to sub stitute another capital instrument for common stockholders’ equity, the Board is seeking additional comment on whether the proposed treatment would, in fact, strengthen the capital positions of banking institutions. Enclosed — for member banks and bank holding companies in this District — is a copy of the text of the Board’s proposal. It will be published shortly in the F e d e r a l R e g is te r , copies will be furnished upon request directed to our Circulars Division (Tel. No. 212-791-5216). Comments on the proposal should be submitted by January 17, 1986 and may be sent to our Bank Analysis De partment. E. Gerald Corrigan, P r e s id e n t. FEDERAL RESERVE 12 CFR Part 225, SYSTEM A P PEN DI X A [ R e g 0 Y Docket No. R-0557] CAP IT AL MAINTENANCE: PERPETUAL DEBT AS PRIMARY CA PITAL AGENCY: Board of Governors of the Federal Re serve ACTION: Pr oposed Rulemaking. SUMMARY: Capital adequacy is one Board of Go vernors of the Federal ana lyz e as conduct related bank the and to of the ho ld ing B oard ann ounced it consider A de qua cy debt the banking would continue to that end to issued prov ide d study debt* by these the as state amend pr imary member pe rpetual of form public to debt 1985, and of Reserve the Board its to primary comment and and whether capital banks and companies time issue a banks Federal that in activities required the to such and In April holding to seek as companies, for At pr oposed include is required individual of ( 1985)) decided has bank the applications, system. members to ^perpetual Board has for are F e d . R e g . 16057 securities [Enc. Cir. N o. 9956] that of Guid el ine s capital banks Guid eli ne s companies, and of of factors super vi sor y companies The and various revised Syste m holding soundness treating capital. issue, Board's bank and levels (50 by critical types safety ch artered System. the an nounced a pp ro p r ia t e state ac quisitions the Reserve in taking action on various mer gers the of System. on this Capital perpetu al bank securities holding meet 2 certain criteria, combined stock R-0557, in order to proposes co nv ertible perpetual component All debt ensure to which should be mailed of the Co n s ti tu t io n Avenue, be de livered Building, of 6?45 inspected and a,m, in Room the i n s t r u m e n t s , perpetual that could that should qu alify common Federal w., N. stock as remains the 5:15 1122, Avenue, Eccles 20th R oo m Board and 20551, or should 2200, Eccles N, W. , betw een weekdays. Building No, Secretary, D, C. Secretary, p,m, Docket System, Washington, of 1986, to Wiles, Reserve Consti tu tio n and refer to Wi l l i am W, to the Office 20th limit of pri ma ry capital, comments*, G ov er nor s hours also Comments must be received by January 17, ADDRESS? of and capital the dominant DATE? Board amount of m a nda to ry pr ef err ed pr i mar y The Comments between the may 8?45 be a,m, and 5:15 poin, weekdays, FOR FU RTH ER Director, INFORMATION Division of (202/452-3354), James (202/452-3513), or for the Deaf CONTACT? Banking E, Joy Scott, W. Anthony Cornyn, Supervision Senior O'Connell, (202/452-3244), G, Board and Attorney, Assistant Regulation Legal Division Te l ec o m m un i c a ti o n of Governors of Device the Federal Reserve System, S UP PL E MEN TA RY INFORMATION? Background. revised Capital Adequacy Guidelines, (1984), the whether to Board treat for pur pos es deferred pe rpetual for debt of the Guidelines, In announcing 50 F e d . R e g . 16057, further study the securities as Since time that its 16064 issud pr im ary there of capital has been 3 a conti nu ed several issued under ba nki ng debt guidelines would qua lify as has ba nki ng 0 General baseR However*, some doing pe ndi ng issue8 with such a have in the qualified the Bank of qu alifyi ng Be ginning located that of Banks in as capital,, At perp et ual a issued institutions have det erm ina ti on of of that to Canadian United debt the 99 years one States securities. expressed the capital statement No perpetual Kingdom In June^ least debt„ 1985*, pri ma ry England» issued May United a min im um ma t ur i t y (primary) institutions so notes debentures issued the adopted by Inspector permit in or ganizations perp etu al Canadian bank interest interest i n s t r u m e n t 8s in capital status o Pur pose of the Proposed R u l e m a k i n g 0 enacted UoS,C„ the International § 3901 et. s e q „ ) which agencies 0 » . . shall m ai nt ai n ade qua te capital as capital for such banking the ap pro pr iat e aut hority of 1966*, by that banking in the has banks approp ri ate and bank levels of deems adopted other holding companies„ capital are designed to of methods Act*, the Su pe rvisory A d eq u a c y levels These and authority and Co m p a ny capital banking levels In stitutions Capital (12 appropriate. 0 to this Holding that esta bl ish mi nimum and appro pr iat e member m i ni m u m agency 1983 to achieve and by such the Fina nc ial of federal institutions Pursuant Bank 1983 Congress Act the es ta blishing § 3907 ) contained the Board directed institutions Federal Federal R es erv e A c t , and Act Supervision cause ba nking (Section 908*, 12 U „ S 0Co the L e nd i n g In November*, Guidelines for m i ni m u m pr otect state and the 4 b an kin g institutions ad di tio na l loan from loss un fo reseen absor pt ion capability, a ddi ti ona l prote ct io n to depositors ba n kin g to institutions take adversity, to to furnish and creditors, adva nt age of provide and to allow opp or tun iti es for sound growth. The Board is proposing this amendment to its Capital Adequacy Guidelines in an attempt to provide state member banks and bank holding companies the flexibility of an additional capital instrument to attain minimum and adequate levels of primary capital. It appears that perpetual debt, if properly structured, might provide some of the traditional protections for the issuing banking organizations provided by other capital instruments. At the same time, however, perpetual debt could not perform these functions to the same degree as common equity. W hen per pe tu a l in compared debt varying as degrees by pref err ed limit combined perp etu al debt, qu a l if y as capital ex cluding more than p er pe tua l with ^25 ma nd a t or y amount and of ma nd at o r y capital ^100 in the pre fer re d in to 33-1/3 stock, the stock m a nda to ry and of total pe rp etual debt, a could conve rt ibl e to instruments, that Thus, capital and pr oposes convertible of shared securities Board percent pr imary limitations limitations instruments. total form of are p r efe rr ed three the convertible Therefore, p e rpe tu al these equity, instrument stock. primary insti tut io n common a capital perp etu al the with could primary banking have no securities, since total 5 pr i ma r y capital excluding these three types of instruments would be $75. Pro posed Criteria sec urities may For qualify the securities possess same is pr ot e ct io n s subject interest to as as the equity., losses of lack the risk. consider pe rpetual debt secu ri tie s meet sh ort co mi ngs The the event would except in The Boards securities certain the debt of the pr ot ections issuer financial to charact er ist ic s A perpetual in Perpetual capital permanence* increase extent of be instrument equityc therefore* and of wo uld if address an to would has proposed capital the that Such unavailable liquidation* that that and provide nonpayment as pr imary co nd itions debt to those the listed above. Board proposes p r i m ar y capital provided same accele ra ti on would Debt. p r im ar y would not provide instrument absorb Perpetual that it meets perpetual debt be treated as the following criteria: 1. The instrument must be unsecured and* if issued by a state member bank* the instrument must also be subordinated to the claims of depositors. 2. The instrument may not provide the noteholder with any right to demand repayment of pr in cipal except in the event of bankruptcy* insolvency* or reorganization. 3o The issue may be redeemed only of the Federal R e se rv e System. 4. The instrument must contain a pr ov i s io n that allows the issuer to reduce and defer interest payments on the perpetual debt in the event* and at the same time* that dividends on any common or preferred stock have been reduced* deferred or eliminated. with the approval 6 5o T re at m en t that If issued by a bank holding co mp any or a state member bank, the instrument must convert automat ic all y to common or pe rpetual pre ferred stock of the issuer in the event that the issuer"s retained earnings and surplus accounts become negative,, If issued by a nonbank s ub sid ia ry of a bank holding co mpany or a s ub sid ia ry of a state member bank, the instrument must convert aut om ati ca lly to common or preferred stock of the issuer's paren t co mpany in the event that the retained earnings and surplus accounts of the issuer's paren t co mp any become n e g a t i v e 0 of common p ri mar y Pe rp etual equity capital P r efe rr ed should for all companieso To that end, of capital p ri mar y c on ve rt ibl e ma nda to r y pri mar y to ex clusive of such also amount pref err ed stock state member include a in an that may bank or bank composite of amount equal be issuing state debt may be in 33-1/3 and the amount of included and p r im ar y to of limit perpetual capital0 A be permitted to securities, debt as pr imary pe rcent in capital, pr oposes conve rt ibl e and pe rp etual the amount m an dat or y pr imary co mpany would of holding stock, securities mandatory to of limited total included bank to limit preferred that believes c o mp one nt and co mp rised of holding total capital primary instruments,. Since the proposed effec t of limiting banks The Board now pe rp etual Board dom in ant pr e v i ou s l y pe rc ent securities,, capital excluding such an be has The proposes se cu rities 20 of member p e rpe tu al perp etu al preferred stock only may The Board capital the the Board that convertible the remain state securities, p er pe tua l d e b t 0 Stock0 comp os ite limi ta tio n could the amount of pe rpetual member bank or bank pref er red holding have stock co mp any the that may 7 include as primary perpetual preferred pub li cation oth erwise pri ma ry This capital, of stock this qualifies capital in should '"grandfather" pr ovision institution that acted in pr oposes prior the pr imary status Board issued n otice as the to good date of that would proposed would all Federal capital this the that seek faith retain rule be to avoid on the that adopted. penalizin g basis of any the existing Guidelines. The the su bject remains enough Board to enable banking a meaningful set the impact institutions, ma nd a to ry conve rti bl e on that former perp et ual pr imary the tend pr eferred following Specific C o m m e n t . issues that it The believes Board are high debt to capital limitation to on equity yet institutions is seeking comment on the ap pr opr ia te Issues For and to use perpetual banking the limit that common capital their r ec ogn iz es since and of larger proposed to ensure or ga niz a t i on s portion The Board a greater smaller to instruments low enough requirements. Board attempting the do minant c o mp on en t of pr imary satisfy have is would than have on more securities. The limit. requests raised by comment on the the proposed rulemak i n g . 1. Whether pe rp etual pr eferred debt instruments can be structured so as to provide the basic protections and safeguards that instruments of pr imary capital are de signed to achieve, and thus whether per petual debt should be given primary capital status. 8 2. Whether the specific conditions pr o po s e d by the Board provide an adequate basis for consid er ati on of perpetual debt as akin to equity and whether they are su ff icient to justify treatment of perpetual debt instruments as pr i m a ry capital. Whether the individual conditions are nece ssa ry or could be mo dified while ac hieving the intended purposes and whether additional conditions should be imposed. 3. Whether the Board should limit the perc en tag e of primary capital that may be composed of instruments other than common equity and whether the limit pro po sed is appropriate. Whether the grandfa th eri ng of perpetual p r efe rr ed stock issued prior to p u bl ic at io n for comment of this proposed rule is appropriate. 4. Whether there is sufficient interest in perpetual debt instruments structured to comply with the proposed conditions and limitations so as to justify*, on a pr actical basis*, issuing a final rule at this time. Regulatory the Flexi Dil it y A n al ys is ado pti on of si g ni fi can t entities (5 these economic wi thi n U.S.C. 601 Ad eq ua c y m ee ti ng the through has bank of the s e g .). The G ui de li ne s that limits not companies^ affect which proposes provide more mi ni mum capital imposed smaller have not certifies expected Re gu la t or y proposal existing does federal not to of to amend small Act its fl ex ibility in standards The per pe tua l state a F l ex ib il it y instrument. on that have number capital Board preferred member hi st or i ca l l y laws duplicate^ and ove rl ap regulations member banks and bank holding companies. Board substantial required the not Board to The banks and issued amounts of such stock. This any the me aning generally ho lding signif ic ant with a the use of an ad di tional will is on previously d ete rm ine d stock p ro pos al s impact et Capital Act. or conflict governing state 9 List of Subjects in 12 C 6 F 0R 0 Part Federal Reserve System; Banks, 225„ Holding Companies, banking; Capital Adequacy; State Member Banks. Pursuant International §& 3907, (BHC 12 Su per vi sor y sections 9 of (FIS and 11(a) Capital Ad eq ua c y 329), 225, of the the Act of Bank the Act), 12 hereby for Holding Part and 225 and 3909), Pub. Company holding the Board's Act Institutions Act proposes is propose d including L c No* to be to (12 and U eS oC 0 amend companies its and Regulation Y, 12 12 UoSoCo 98-181, IN BANK CONTROL amended, Title under §§ 1844(b), IX (12 authority 1817(j)(13), U eS 0C 0 §§ 3907 by revising App en dix A to read as follows; APPENDIX A -- Capital Adequacy Guidelines Companies and State Member Banks 12 U.S.C. as set forth below; cited in this part 1818(b), the U 0S c C 0 § 1818; 225 - BANK HOLDING CO MP ANIES AND CHANGE CoFoRo (ILSA), Reserve bank A pp en di x A of 1983 under Financial Federal Board Gu idel ines state member banks, 12 1966 au th ority the § 1844(b); 324, Part of UoSoCo Act Part Board's section 5(b) §§ 248, CoFoRc the Lending Su pe rvision 3909; Act), to * * * for Bank Holding 10 De fin it io n of Capital to be Used in D e t e r m i n i n g Capita l A d e q u a c y of Bank Holding Co mp a n ie s and State Member Banks Prim ar y ca pital co mpo n e nt s tJ The components of pr i m a ry capital ares -- common stock, -- perpetual pr eferred stock (preferred stock that does not have a stated ma t ur i t y date and that may not be redeemed at the option of the holder), — surplus (excluding preferred s t o c k ) , surplus relati ng to limited-life -- undivided profits, — co nti ng enc y and other -- mand ato ry c on ver ti ble — capital reserves, instruments, allowance for possible loan and lease losses (exclusive of al located transfer risk reserves), -- mi no ri t y interest in equit y co nso lidated subsidiaries, — perpetual debt accounts of instrumentsJLi/ Cr i t e r i a for determining the Cap it al Status of P e rpe tu al Debt Ins tr ume nt s of Bank Holding C o mpa ni es and State Member B a n k s . 1. The instrument must be unsecured and, if issued by a state member bank, the instrument must als o be subordinated to the claims of d e p o s i t o r s . V The m ax imu m composite amount of m a nda to ry convertible securities, perpetual debt and p e rpe tu al preferred stock that may be co unted as primary capital is limited to 33-1/3 percent of pr im ary capital, ex cl usive of these types of i n s t r u m e n t s „ Mo pe rpe tu al preferred stock issued prior to November , 1985, [prior to the publication of the proposal to adopt this 33=1/3 per cent limit] shall forfeit its status as pr imary capital as a result of adoption of this p r o v i s i o n 0 (Amounts o ut sta nd ing in excess of the 33=1/3 pe rcent limitation may be counted as se con dary capital provided they meet the requir em ent s of secondary capital i n s t r u m e n t s .) **/ See the de fin it ion al section below that lists the criteria for perp etu al debt instruments to q u al i f y as pri ma ry c a p i t a l 0 11 20 The instrument may not provide the noteholder with any right to demand repayment of principal except in the event of bankruptcy, insolvency, or reorganization. 30 The issue may be redeemed only of the Federal Reserve System. 40 The instrument must contain a provision that allows the issuer to reduce and defer interest payments on the perpetual debt in the event, and at the same time, that dividends on any common or preferred stock have been reduced, deferred or eliminated„ 5, If issued by a bank holding company or a state member bank, the instrument must convert automa tic al ly to common or pe rp etual preferred stock of the issuer in the event that the i s s u e r 5s retained earnings and surplus accounts become negative. If issued by a nonbank su bs idiary of a bank holding company or a subs id iar y of a state member bank, the instrument must convert automatically to common or pref er red stock of the i s s u e r 8s parent company in the event that the retained earnings and surplus accounts of the issuer's parent company become negative. 6 . The maximum amount of such perpetual debt, when considered together with ma nd a t or y convertible securities and perpetual pr ef erred stock, that may be counted as pr im ary capital is limited to 33-1/3 percent of such pr im ary capital, exclusive of these three i n s t r u m e n t s 0 [Note that a similar 20 percent limit on ma nd atory convertible securities shall remain in effect.] By order Reserve System, of the November Board 14, (signed) of Governors with of the the approval Federal 1985. William W. Wiles W i l li a m W. Wiles Secretary of the Board
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