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Appeals of Material Supervisory Determinations: Guidelines & Decisions

SARC- 97-02 (September 19, 1997)

The Supervision Appeals Review Committee of the Federal Deposit Insurance Corporation (“FDIC”) on September 16, 1997, considered your appeal of a material supervisory determination made by the FDIC’s San Francisco Regional Office (“Regional Office”) regarding the status of your recently issued preferred stock.  A ruling not in your favor has been decided and is conveyed in this letter.

The FDIC’s leverage and risk-based capital standards define Tier 1 capital and allow banks to include noncumulative perpetual preferred stock as a component of Tier 1 capital.  Section 325.2(o) of the FDIC’s regulations define this form of preferred stock as “perpetual preferred stock (and related surplus) where the issuer has the option to waive payment of dividends and where dividends so waived do not accumulate to future periods nor do they represent a contingent claim on the issuer.”

In describing the dividend payment terms on the preferred stock, the May 6, 1997, Certificate of Determination of [Bank] (“Bank”), for this stock states that dividends are 

payable annually in cash on the first day of July…. Such dividends shall not be cumulative but the payment thereof shall constitute an obligation of the Corporation to the holders…as of the date any such annual dividend becomes due and payable, and shall, if not then payable in cash, be payable as hereinafter set forth.

In the event the Corporation is unable to make a cash payment equal to the amount of any annual or other dividend payment when due and payable, the Corporation shall issue… a dividend in the form of Common Stock…

The Bank’s Disclosure Statements to purchasers of the preferred stock includes a similar description of the dividend payment terms.

Clearly, the Bank does not have an option to waive the payment of dividends.  Dividends must be paid each year, either in cash or in common stock of the Bank.

The Bank’s representative stated that the Bank relied upon the “best publicly available information” about the characteristics necessary for a preferred stock issue to qualify for Tier 1 capital treatment.  The representative also suggests that the FDIC staff’s interpretation regarding the payment of “in-kind” dividends is unique because “[w]e are unaware of any other similar interpretation by any of the other federal banking agencies.”  However, in its Commercial Bank Examination Manual, the Federal Reserve Board (“FRB”) has articulated an identical position on “in-kind” dividends as the FDIC.  Section 3020.1 (November 1994) of this manual states that

Banks may include perpetual preferred stock in Tier 1 capital only if the stock is           noncumulative.  A noncumulative issue may not permit the accruing or payment of unpaid dividends in any form, including the form of dividends payable in common stock.

The FRB staff has advised us that this interpretation remains in effect.  The staff of the Office of the Comptroller of the Currency (“OCC”) has indicated that, although a perpetual preferred stock issue with “in-kind” dividend payments normally would not qualify as a Tier 1 capital component, the OCC has approved Tier 1 capital treatment for such stock on an exception basis for some problem institutions that needed to raise capital.

Thus, despite the Bank representative’s apparent lack of awareness of interpretations on the “in-kind” dividend issues that differ from the OTS’, the FRB has published such an interpretation.  Given the differences in the FDIC’s and the OTS’ definitions of “noncumulative perpetual preferred stock,” it could be argued that the Bank’s representative and investment advisor did not adequately research the regulatory capital requirements for this type of stock.  By discovering the FRB’s published interpretation on this subject, they should have realized that interpretive differences exist among the agencies and specifically pursued this matter with the Regional Office.

The Regional Office closely monitored the progress of the Bank’s recapitalization efforts, but the Bank’s representative specifically asked the Regional Office to opine on only one issue with respect to the preferred stock: one aspect of the stock’s conversion provisions.  This conversion language appeared on a one and a half page draft “term sheet” for the preferred stock which the Bank’s representative faxed to the Regional Office on April 21, 1997.  The draft term sheet was submitted to the Regional Office without a cover letter and the case manager had to call the Bank’s representative in order to determine the purpose of the transmission.  Upon calling the Bank’s representative, the only reason given for transmission of the draft term sheet was to review it in relation to the conversion provisions.  This was done telephonically.  Although the term sheet also discloses that dividends would be payable in common stock if the issuer is unable to make a cash dividend payment, the Bank’s representative did not request that the Regional Office review that stock’s dividend provisions described on the term sheet.  In addition, neither the Bank nor its representative asked the Regional Office for, and the Regional Office did not prepare, a written ruling stating that the Bank’s preferred stock would qualify as Tier 1 capital.

Accordingly, the Bank should not treat the perpetual preferred stock as Tier 1 capital.  However, the recent joint examination of the Bank, which is currently being processed, may provide a basis for the FDIC to modify its position regarding the level of Tier 1 capital that the Bank needs to maintain. 


Last Updated 06/30/2005 Legal@fdic.gov