The Federal Reserve launched the 2013 capital planning and stress testing process for large bank holding companies (“BHCs”) with the publication, on November 9, 2012, of two sets of instructions: one set for the 19 BHCs that participated in the 2011 Comprehensive Capital Analysis and Review (“CCAR”) process (“CCAR BHCs”) and another set for the 11 other U.S.-domiciled, top-tier BHCs with total consolidated assets of $50 billion or more that did not participate in the 2011 CCAR process (“non-CCAR BHCs”). On the same day, the Federal Reserve joined with other U.S. banking agencies to announce that recent proposals to implement Basel III in the United States will not become effective on January 1, 2013.

The Federal Reserve’s instructions for the CCAR BHCs, which reveal how the Dodd-Frank Act’s stress testing requirements will be integrated with the Federal Reserve’s capital planning requirements, are instructive for the non-CCAR BHCs that will become subject to Dodd-Frank stress-testing requirements in the 2014 capital planning cycle. Similarly, nonbank financial companies designated by the Financial Stability Oversight Council (“FSOC”) for supervision by the Federal Reserve will be subject to Dodd-Frank stress-testing requirements and, under a proposal by the Federal Reserve, would also be required to submit annual capital plans to the Federal Reserve.

For the CCAR BHCs, the two most significant changes from the 2012 process are:

…continue reading: Fed Begins 2013 CCAR Capital Planning Process for Large Banks

The Federal Reserve’s decision this week to confer Comprehensive Consolidated Supervision (“CCS”) status to three state-owned Chinese banks has been long awaited and paves the way for major Chinese banks to enter retail commercial banking in the United States by acquiring U.S. banks. We view the Federal Reserve’s decision, which is the first CCS determination with respect to a major jurisdiction in nearly 10 years, as encouraging for banks from other emerging economies that wish to expand their activities in the United States by acquiring U.S. banks or electing to become financial holding companies (“FHCs”). Since many developed economies have attained CCS status, the key markets that might, over time, indirectly benefit from the China CCS determination include Dubai, India, Malaysia, Saudi Arabia, Singapore and South Africa. Brazilian and Mexican banks already benefit from earlier CCS determinations. There are, however, a few lessons to be learned from the Chinese experience, which we take to mean that CCS determinations will require patience and persistence. These lessons are:

• A willingness on the part of the Chinese government and major Chinese banks to make the CCS determination a policy priority across a range of trade, economic and strategic relationships;
• A willingness to invest in smaller U.S. community and regional banks by Chinese banks with a traditional commercial banking profile;
• A strong, reciprocal desire by U.S. financial institutions to enter or expand their presence in the Chinese market;
• A determined effort on the part of the Chinese government and Chinese regulatory authorities to enhance their overall supervisory framework, as well as their anti-money laundering controls; and
• An appreciation that, in today’s environment, CCS determinations may be incremental and more likely to be made on a bank-by-bank basis (or at least with respect to similar banks in the same country).

…continue reading: Federal Reserve’s Chinese Bank Determination Has Broader Implications

The Federal Reserve has released proposed rules to implement the enhanced supervisory and prudential requirements in Sections 165 and 166 of the Dodd-Frank Act. These proposed rules represent the Federal Reserve’s primary effort, one and a half years after the enactment of Dodd-Frank, to put in place prudential standards that will govern the largest bank holding companies in the United States and any nonbank financial firm designated in the future as systemically important and subject to Federal Reserve oversight. Our memorandum, Federal Reserve Proposes Enhanced Prudential Standards and Early Remediation Requirements For Large BHCs and Nonbank SIFIs, describes the Federal Reserve’s proposal.

Of particular interest, the Federal Reserve is proposing, for the first time, to formally limit the consolidated exposures that a large BHC or nonbank SIFI, together with its subsidiaries, may have to any other counterparty at 25% of its capital and surplus, and to limit such exposures between the very largest institutions to 10% of capital and surplus. In addition, the Federal Reserve is proposing, for the first time, to require large BHCs and nonbank SIFIs to comply with a formal regulatory liquidity standard. While these proposed rules are consistent with Dodd-Frank’s requirements, and in some cases tie in with international regulatory efforts, they represent a new chapter in the regulation of large banks and non-bank financial institutions and efforts to reduce systemic risk. The proposed rules, however, defer rulemaking on several important topics to a future release. For example, despite press reports, the proposed rules do not contain the Basel Committee’s G-SIB surcharge but instead state that the Federal Reserve will implement the surcharge by 2014, with it taking effect between 2016 and 2019.

The full memorandum is available here.

The Collins Amendment, originally drafted by the FDIC staff and reflecting views held by Chairwoman Bair, imposes, over time, the leverage and risk-based standards currently applicable to U.S. insured depository institutions on U.S. bank holding companies, including U.S. intermediate holding companies of foreign banking organizations, thrift holding companies and systemically important nonbank financial companies. One of the effects of the Collins Amendment is to eliminate trust preferred securities as an element of Tier 1 capital. Implementing regulations must be issued no later than 18 months from the bill’s effective date. As with all changes in capital requirements, there are highly negotiated transition periods and grandfathering exemptions, which we describe below. Please see a more complete implementation timeline at the end of this memorandum.

…continue reading: Collins Amendment Sets Minimum Capital Requirements

On June 25, 2010, the Senate-House conference on the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Bill”) agreed on the final legislative text of the Bill, including Section 716 (the “Swap Pushout Rule”). The Swap Pushout Rule is a revised version of a provision originally introduced by Senator Blanche Lincoln (D–AR) to the Senate Agriculture Committee. The provision led to significant controversy, including the objections of several key politicians and regulators. The controversy continued through the early morning hours of June 25, when compromise language was finally agreed upon. The result is a provision that includes an unusual number of ambiguities and apparent contradictions.

…continue reading: Dodd-Frank Act Finalizes Swap Pushout Rule

For the second time since adopting its Final Statement of Policy for Failed Bank Acquisitions (the “Policy Statement”), the FDIC has issued “Questions and Answers” (the “Revised Q&As”) about the Policy Statement that appear to make it more difficult for private investors to avoid the onerous standards and requirements of the Policy Statement. [1] The FDIC will now presume that, if more than two-thirds of the total voting stock of an insured depository institution or its holding company that acquires a failed bank or thrift is held by private investors that each own 5% or less of the voting stock, the private investors are acting in concert as a single investor group. The private investors will be subject to the requirements of the Policy Statement unless they can satisfy the FDIC that the presumption has been rebutted. This position seems to confirm the FDIC’s preference for transactions in which an existing bank holding company owns at least two-thirds of the voting stock of the acquiring depository institution or its holding company or is itself the acquirer (with new private investors limited to no more than one-third of the existing bank holding company’s total equity).

…continue reading: FDIC and Private Capital: Moving the Goal Lines

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk & Wardwell LLP client memorandum by Ms. Nazareth together with Donald Bernstein, Luigi De Ghenghi, John Douglas, Randall Guynn, Arthur Long, Margaret Tahyar and Reena Agrawal Sahni.  The memorandum, including an appendix table summarizing the key differences between the resolution of assets and claims under the Bankruptcy Code and under the House’s draft bill, is available here.

The legislative season for financial regulatory reform is now in full swing. In the last two weeks, the leadership of the House Financial Services Committee and Treasury have jointly proposed a revised version of the Obama Administration proposals of last summer. Thereafter, the House Financial Services Committee began to amend the proposal, titled the Financial Stability Improvement Act of 2009, and the Chairman of the Committee, Representative Barney Frank (D-MA), has made clear that further changes will be made next week. This week, Senator Christopher Dodd (D-CT), Chairman of the Senate Banking Committee, released his own competing discussion draft of regulatory reform, entitled the Restoring American Financial Stability Act of 2009.

This memorandum analyzes the resolution provisions in the House Interim Version (by which we mean the House Financial Services Committee’s version as of November 6, 2009). We also identify any significant differences between the House Interim Version and the Senate Banking Committee’s discussion draft. This memorandum focuses on the key issues raised by the resolution of financial companies that could, in the future, be deemed to be systemically important. While the proposed resolution authority is only one of several regulatory restructuring proposals under consideration both in the United States and abroad, we view it as the most technically challenging. It is also key to many other reforms since it will be at the core of the political compromise around the knotty problems of “too big to fail,” moral hazard, and the global interconnectedness of highly leveraged institutions.

…continue reading: The House and Senate Debate Resolution Authority

(Editor’s Note: This post from Margaret E. Tahyar is based on a David Polk & Wardwell LLP client memorandum by Luigi De Ghenghi, John Douglas, Randy Guynn, Arthur Long, Bill Taylor, and Reena Agrawal Sahni.)

At a meeting of the Board of Directors of the FDIC on August 26, 2009, the FDIC adopted a Final Statement of Policy on Qualifications for Failed Bank Acquisitions. The final policy statement establishes standards and requirements for private investors acquiring or investing in failed insured depository institutions, including through holding companies formed for that purpose. While the final policy statement is a substantial improvement over the proposed policy statement issued on July 2, 2009, it nevertheless subjects private investors to more onerous requirements than those applicable to existing banks, thrifts and their respective holding companies, which explicitly remain the FDIC’s preferred buyers of failed insured depository institutions. Just how onerous these requirements will be is unclear, as the final policy statement leaves a number of terms and concepts undefined and thus subject to the discretionary interpretation of the FDIC. The FDIC Board of Directors has not only reserved the right to modify the policy statement in specific situations, but also agreed to revisit the policy statement in six months.

Highlights

Scope. The policy statement will not apply to private investors with 5% or less of total voting power; nor will it apply to pre-existing investments in failed depository institutions.

Term. Upon application to the FDIC, investors may seek relief from the policy statement if the institution invested in has maintained a composite CAMELS rating of 1 or 2 continuously for seven years.

Capital. The FDIC backed off its proposed 15% Tier 1 leverage requirement, but instead imposed a minimum 10% ratio of Tier 1 common equity to total assets. While the 10% requirement probably will not eliminate private capital bids for failed banks, at least in the near term, it represents a financial penalty that will reduce any potential bid, thus hindering private investors.

Cross Guarantee. The FDIC backed off its initial proposal to impose cross-guarantee liability where there is majority common ownership, increasing the common ownership threshold to 80% and clarifying the intent to impose that liability on common owners directly. While the 80% test is a significant improvement, it still represents a deterrent for prospective private investors.

Source of Strength. The FDIC completely eliminated the proposed source of strength requirement, but underlined the source of strength obligations of a depository institution’s holding company by deeming an insured depository institution “undercapitalized” for purposes of prompt corrective action if its Tier 1 common equity ratio drops below 10%.

Transactions with Affiliates. The final policy statement goes well beyond Section 23A of the Federal Reserve Act by flatly prohibiting transactions with private investors, their investment funds and any of their respective affiliates and by defining affiliates by reference to a 10% level of ownership.

Bank Secrecy Jurisdictions. The FDIC retained the ability to refuse to allow investors from so-called bank secrecy jurisdictions to participate.

Holding Period. The FDIC retained the minimum three-year ownership requirement, although it will permit transfers to affiliates that agree to the provisions of the policy statement, subject to FDIC consent, and it excluded mutual funds from this minimum holding period requirement.

Prohibited Structures. The FDIC retained the ability to preclude ownership structures that the FDIC determines to be “complex and functionally opaque.”

Precluded Investors. The policy statement retains a prohibition on investors that hold 10% or more of the equity of an institution in receivership from bidding on that institution.

Disclosures. Investors subject to the policy statement are required to provide substantial information to the FDIC in connection with any proposed bid.

Despite the compromises reflected in the final policy statement, the FDIC Board was unable to achieve unanimity, with the final policy statement being approved by a 4-1 vote. John Bowman, Acting Director of the Office of Thrift Supervision, cast the opposing vote, stating that the lack of empirical data supporting the policy statement made it impossible to evaluate its benefits.

In the memorandum, FDIC Extends Cautious Welcome to Private Capital Investments in Failed Banks, Davis Polk analyzes the final policy statement in greater detail. Because of the ambiguities in the final policy statement and the FDIC’s discretion to interpret and apply the statement, it will be more important than ever for prospective investors to engage the FDIC very early on in the process of any proposal to acquire a failed insured depository institution.