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Sep 23
2010
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DODD-FRANK AND YOUR QUEST FOR CAPITALPosted by Jeff Gerrish in Jeff Gerrish on Community Banking   |
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What it means—and what it doesn't mean—in the real world
Looking back at a key Fed policy statement in Collins’ light
In connection with raising capital in the post-Dodd-Frank world, community banks need to understand the impact of the “Small One-Bank Holding Company Policy Statement.” The Collins Amendment, as originally proposed, would have eliminated the benefit to small bank holding companies (under $500 million in consolidated assets) afforded by that Federal Reserve policy statement. However, the final law preserved the ability of banks under $500 million to avail themselves of the government largesse represented by it.
In a nutshell (with some qualifications, hey, this is the federal government, as you know), the Small Bank Holding Company Policy Statement provides that a bank holding company with consolidated assets less than $500 million is only tested for capital at the bank level. This means, as a practical matter, that the bank holding company can generate cash through any appropriate means and then downstream that cash into the bank, where it shows up as capital. This is simply because the capital for the organization is tested on a bank-only basis.
For example, to generate cash, the holding company could borrow money from an institutional lender, e.g., a bankers’ bank.
Or it could borrow money from an insider, e.g., a director.
Or it could borrow money from an unaffiliated individual.
Or sell any type of equity—preferred, common, cumulative, non-cumulative, perpetual, non-perpetual, etc.
Since there is no capital test at the small bank holding company, even in the post-Collins era, there is no need to worry about whether the instrument issued by the holding company of less than $500 million of consolidated assets counts as capital at the holding company level or on a consolidated basis.
Generate whatever cash you can and downstream it into the bank and go on your merry way.
The Collins Amendment did deter future use of trust preferreds for any bank holding company. That is really a nonevent since there is no trust preferred to be had, as a practical matter, for banks under $500 million in any event.
Understanding Dodd-Frank’s accredited investor issue
The only other major impact on raising capital from the Dodd-Frank law on banks under $500 million is the change in the definition of “Accredited Investor.”
Most small bank holding companies, when they attempt to raise equity capital, will use an exemption from SEC registration (assuming they are not already a public company) under Rule 506.
Rule 506, in general terms, allows the company to raise capital from an unlimited number of “accredited” investors, and up to 35 non-accredited investors.
Accredited Investors are generally defined to be “rich and smart” people. Dodd-Frank requires them to be richer (not necessarily smarter). Accredited investors must meet either an income or a net worth test. The income test was unchanged by Dodd-Frank, but the net worth test was changed so that instead of simply $1 million net worth, it now is $1 million net worth with the exclusion of the investor’s principal residence. The SEC has already wrangled with this “principal residence” exclusion and come to the conclusion (the only logical one) that it excludes the net equity of the investor in the principal residence, not the “value” of the principal residence, as the law seems to imply.
The bottom line of all this for community banks of any size, but especially those under $500 million, is that the pool of potential investors will have narrowed because the definition of “Accredited Investor” has narrowed.
If you’re larger than $500 million…
What about those banks above $500 million that do not get to take advantage of Dodd-Frank’s “The Government is here to help you with the Small Bank Holding Company Policy Statement”?
They are viewed on a consolidated capital basis. It is more important for them to determine if the instrument issued at the holding company level qualifies as capital.
Here’s the deal: The regulators are moving heavily toward requiring equity and against anything that looks like debt.
Any new issues of trust preferred will no longer count as capital. (Some believe it never really should have, since it was basically long-term interest-only debt.) For those bank holding companies over $500 million, then, something that actually counts as capital, equity, perpetual preferred stock, or a few other variations, will need to be utilized.
One point that relates to everyone: Every bank should have a Capital Plan, and a Capital Contingency Plan, in the event additional capital is needed.
About the Author
Gerrish formerly served as Regional Counsel for the Memphis Regional Office of the FDIC, with responsibility for all legal matters, including cease-and-desist and other enforcement actions. Before coming to Memphis, Gerrish was with the FDIC Liquidation Division in Washington, D.C. where he had nationwide responsibility for litigation against directors of failed banks.
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Although there are a number of “carve-outs” for community banks in the Dodd-Frank Act, there are still a number of issues that impact community banks’ ability to raise capital. The “Collins Amendment” is a critical one. This is the first of several blogs I’ll be writing relating to the Act—all 2,319 pages of it—as it relates to community banks.
Looking back at a key Fed policy statement in Collins’ light
In connection with raising capital in the post-Dodd-Frank world, community banks need to understand the impact of the “Small One-Bank Holding Company Policy Statement.” The Collins Amendment, as originally proposed, would have eliminated the benefit to small bank holding companies (under $500 million in consolidated assets) afforded by that Federal Reserve policy statement. However, the final law preserved the ability of banks under $500 million to avail themselves of the government largesse represented by it.
In a nutshell (with some qualifications, hey, this is the federal government, as you know), the Small Bank Holding Company Policy Statement provides that a bank holding company with consolidated assets less than $500 million is only tested for capital at the bank level. This means, as a practical matter, that the bank holding company can generate cash through any appropriate means and then downstream that cash into the bank, where it shows up as capital. This is simply because the capital for the organization is tested on a bank-only basis.
For example, to generate cash, the holding company could borrow money from an institutional lender, e.g., a bankers’ bank.
Or it could borrow money from an insider, e.g., a director.
Or it could borrow money from an unaffiliated individual.
Or sell any type of equity—preferred, common, cumulative, non-cumulative, perpetual, non-perpetual, etc.
Since there is no capital test at the small bank holding company, even in the post-Collins era, there is no need to worry about whether the instrument issued by the holding company of less than $500 million of consolidated assets counts as capital at the holding company level or on a consolidated basis.
Generate whatever cash you can and downstream it into the bank and go on your merry way.
The Collins Amendment did deter future use of trust preferreds for any bank holding company. That is really a nonevent since there is no trust preferred to be had, as a practical matter, for banks under $500 million in any event.
Understanding Dodd-Frank’s accredited investor issue
The only other major impact on raising capital from the Dodd-Frank law on banks under $500 million is the change in the definition of “Accredited Investor.”
Most small bank holding companies, when they attempt to raise equity capital, will use an exemption from SEC registration (assuming they are not already a public company) under Rule 506.
Rule 506, in general terms, allows the company to raise capital from an unlimited number of “accredited” investors, and up to 35 non-accredited investors.
Accredited Investors are generally defined to be “rich and smart” people. Dodd-Frank requires them to be richer (not necessarily smarter). Accredited investors must meet either an income or a net worth test. The income test was unchanged by Dodd-Frank, but the net worth test was changed so that instead of simply $1 million net worth, it now is $1 million net worth with the exclusion of the investor’s principal residence. The SEC has already wrangled with this “principal residence” exclusion and come to the conclusion (the only logical one) that it excludes the net equity of the investor in the principal residence, not the “value” of the principal residence, as the law seems to imply.
The bottom line of all this for community banks of any size, but especially those under $500 million, is that the pool of potential investors will have narrowed because the definition of “Accredited Investor” has narrowed.
If you’re larger than $500 million…
What about those banks above $500 million that do not get to take advantage of Dodd-Frank’s “The Government is here to help you with the Small Bank Holding Company Policy Statement”?
They are viewed on a consolidated capital basis. It is more important for them to determine if the instrument issued at the holding company level qualifies as capital.
Here’s the deal: The regulators are moving heavily toward requiring equity and against anything that looks like debt.
Any new issues of trust preferred will no longer count as capital. (Some believe it never really should have, since it was basically long-term interest-only debt.) For those bank holding companies over $500 million, then, something that actually counts as capital, equity, perpetual preferred stock, or a few other variations, will need to be utilized.
One point that relates to everyone: Every bank should have a Capital Plan, and a Capital Contingency Plan, in the event additional capital is needed.
About the Author
Gerrish formerly served as Regional Counsel for the Memphis Regional Office of the FDIC, with responsibility for all legal matters, including cease-and-desist and other enforcement actions. Before coming to Memphis, Gerrish was with the FDIC Liquidation Division in Washington, D.C. where he had nationwide responsibility for litigation against directors of failed banks.
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Gerrish can be reached at jgerrish@gerrish.com, and the firm’s website, www.gerrish.com. - You can get word about these columns the week they are posted by subscribing to ABA Banking Journal Report e-letter. It's free and takes only a minute to sign up for Click here
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