Legal Alerts

The Dodd–Frank Wall Street Reform and Consumer Protection Act: How Will it Impact on Capital of Community Banks and Bank Holding Companies?


One of the most significant and carefully scrutinized provisions of the Dodd-Frank Wall Street Reform and Consumer Protections Act (“Act”) is Section 171 of the Act, which has commonly been referred to as the Collins Amendment.  In the end, this Section of the Act was amended in ways that were favorable to small bank holding companies and community banks generally.

Which holding companies will be subjected to new consolidated capital ratio standards?

Section 171 requires federal regulators to establish minimum leverage capital ratios and minimum risk based capital requirements on a consolidated basis for insured depository institutions, depository institution holding companies and nonbank financial companies that are not be less than the generally applicable leverage capital requirements and generally applicable risk-based capital requirements set forth in section 38 of the Federal Deposit Insurance Act. 

This means that large bank holding companies will be subject to the same capital requirements as their subsidiary banks.  Clearly, this is a tightening of the capital standards for large bank holding companies. 

Small bank holding companies (those with assets of less than $500 million) are exempt.  Section 171 does not apply to any small bank holding company that is subject to the Small Bank Holding Company Policy Statement of the Board of Governors of the Federal Reserve System.  This is fortunate for community banks.  If small bank holding companies had not been exempted from the requirements of Section 171, many could have found themselves undercapitalized because of debt owing to a correspondent bank stock lender, to shareholders or others that would be treated as debt and not regulatory capital on a consolidated basis.

Is there any future for trust preferred securities?

One of the key ways that Section 171 tightens the capital standards for bank holding companies is through limits placed on trust preferred securities. 

Pursuant to Section 171, a depository institution holding company with total consolidated assets of less than $15 billion as of December 31, 2009 may continue to include in regulatory capital trust preferred securities that were issued prior to May 19, 2010.  No trust preferred securities may be included in regulatory capital if they are issued after May 19, 2010.  Further, depository institutions with more than $15 billion in total consolidated assets will be required to phase-out over a period of three years trust preferred securities issued before May 19, 2010 that are presently included in regulatory capital.

It was a victory for community banks that trust preferred securities issued before May 19, 2010 can continue to be included in regulatory capital of depository institution holding companies with less than $15 billion in total consolidated assets.  From this point on, however, trust preferred securities will not be a capital source for depository institution holding companies.  

Are higher capital ratios coming?

Section 171 of the Act has two other provisions of note.  First, the Act requires the Comptroller General to conduct a study of the access of smaller insured depository institutions (defined as institutions with total consolidated assets of $5 billion or less) to capital.  Section 171 also charges the federal banking agencies to develop capital requirements that address not only the risks posed by depository institutions, depository institution holding companies and nonbank financial companies to the entities themselves, but also to other public and private stakeholders.  The risks to be considered by the regulators include the risks of derivatives activities, securitizations, repurchases, credit concentrations and market-share concentrations.

Although to date the federal banking agencies have imposed increased capital requirements through the examination process on a case-by-case basis, a plain reading of Section 171 of the Act suggests that all financial institutions may soon face increased leverage and risk-based capital requirements. 

Will changes to the definition of “accredited investor”  inhibit capital raising?

As bank holding companies consider Section 171 of the Act and examine their overall capital needs, they should also look carefully at Section 413 of the Act.  

Many bank holding companies prefer to raise capital through a private placement of stock to accredited investors that is exempt from registration under state and federal securities laws (in particular, Regulation D of the Securities Act of 1933).  Section 413 of the Act instructs the SEC to make a significant change to the definition of “accredited investor” that may reduce the pool of potential accredited investor purchasers in a stock offering.  Prior to the Act, an accredited investor included any natural person with a net worth of $1 million (commonly called the “net worth test”).  The Act directs the SEC to adjust the net worth standard to $1 million, excluding the value of the primary residence of such natural person.  It is therefore likely that fewer potential investors in a bank holding company will qualify as an accredited investor.

Significantly, the Act did not change the “net income test” for whether a natural person is an accredited investor.  This means that a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year is still an accredited investor.  The Act, however, instructs the SEC to review periodically and, if necessary, adjust the definition of accredited investor as such definition applies to natural persons.  This means that the SEC may in the future make changes to both the net worth test and net income test that could further reduce the pool of accredited investors for a bank holding company’s stock.  A bank holding company that anticipates it will need to raise additional capital may want to conduct a private placement offering before the net income test is changed.

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