(1) Subpart C of this part provides criteria
for capital instruments to qualify as common equity tier 1 capital.
This section describes how certain criteria apply to capital instruments
issued by bank holding companies and covered savings and loan holding
companies that are organized as legal entities other than stock corporations,
such as limited liability companies (LLCs) and partnerships.
(2) Holding companies are
organized using a variety of legal structures, including corporate
forms, LLCs, partnerships, and similar structures.
2 In the Board’s experience, some depository institution
holding compa
nies that are organized in non-stock form issue multiple classes
of capital instruments that allocate profit and loss from a distribution
differently among classes, which may affect the ability of those classes
to qualify as common equity tier 1 capital.
3(3) Common equity
tier 1 capital is defined in section 217.20(b). To qualify as common
equity tier 1 capital, capital instruments must satisfy a number of
criteria. This section provides examples of the application of certain
common equity tier 1 capital criteria that relate to the economic
interests in the company represented by particular capital instruments.
(c)
Examples. The following examples show how the criteria for common equity tier
1 capital apply to particular partnership or LLC structures.
4(1) LLC with one class of membership interests.
(i) An LLC
issues one class of membership interests that provides that all holders
of the interests bear losses and receive dividends proportionate to
their levels of ownership.
(ii) Provided that the other criteria
in section 217.20(b) are met, the membership interests would qualify
as common equity tier 1 capital.
(2) Partnership
with limited and general partners.
(i) A partnership has
two classes of interests: General partnership interests and limited
partnership interests. The general partners and the limited partners
bear losses and receive distributions allocated proportionately to
their capital contributions. In addition, the general partner has
unlimited liability for the debts of the partnership.
(ii) Provided that the
other criteria in section 217.20(b) are met, the general and limited
partnership interests would qualify as common equity tier 1 capital.
The fact of unlimited liability of the general partner is not relevant
in the context of the eligibility criteria of common equity tier 1
capital instruments, provided that the general partner and limited
partners share losses equally to the extent of the assets of the partnership,
and the general partner is liable after the assets of the partnership
are exhausted. In this regard, the general partner’s unlimited liability
is similar to a guarantee provided by the general partner, rather
than a feature of the general partnership interest.
(3) Senior and junior classes of capital instruments.
(i) An LLC issues two types of membership
interests, Class A and Class B. Holders of Class A and Class B interests
participate equally in operating distributions and have equal voting
rights. However, in liquidation, holders of Class B interests must
receive the entire amount of their contributed capital in order for
any distributions to be made to holders of Class A interests.
(ii) Class B interests have
a preference over Class A interests in liquidation and, therefore,
would not qualify as common equity tier 1 capital as the Class B interests
are not the most subordinated claim (criterion (i)) and do not share
losses proportionately (criterion (viii) (section 217.20(b)(1)(i)
and (viii), respectively).
(A) If all other criteria are satisfied, Class
A interests would qualify as common equity tier 1 capital.
(B) Class B interests may qualify
as additional tier 1 capital, or tier 2 capital, if the Class B interests
meet the applicable criteria (section 217.20(c) and (d)).
(4) LLC with two classes of membership interests.
(i) An LLC issues two types of membership
interests, Class A and Class B. To the extent that the LLC makes a
distribution, holders of Class A and Class B interests share proportionately
in any losses and receive proportionate shares of contributed capital.
To the extent that a capital distribution includes an allocation of
profits, holders of Class A and Class B interests share proportionately
up to the point where all holders receive a specific annual rate of
return on capital contributions, and, if the distribution exceeds
that point, holders of Class B interests receive double their proportional
share and holders of Class A interests receive the remainder of the
distribution.
(ii)
Class A and Class B interests would both qualify as common equity
tier 1 capital, provided that under all circumstances they share losses
proportionately, as measured with respect to each distribution, and
that they satisfy the common equity tier 1 capital criteria. The holders
of Class A and Class B interests may receive different allocations
of profits with respect to a distribution, provided that the distribution
is made simultaneously to all members of Class A and Class B interests.
Despite the potential for disproportionate profits, Class A and Class
B interests have the same level of seniority with regard to potential
losses and therefore they both satisfy all the criteria in section
217.20(b), including criterion (ii) (section 217.20(b)(1)(ii)).
(5) Alternative LLC with two classes of membership
interests.
(i) An LLC issues two types of membership
interests, Class A and Class B. In the event that the LLC makes a
distribution, holders of Class A interests bear a disproportionately
low level of any losses, such that the Class B interests bear a disproportionately
high level of losses at the distribution. In contrast to the example
in paragraph (c)(4) of this section, the different participation rights
apply to distributions in situations where losses are allocated, including
losses at liquidation.
(ii) Because holders of the Class A interests do not bear a proportional
interest in the losses (criterion (ii) (section 217.20(b)(1)(ii)),
the Class A interests would not qualify as common equity tier 1 capital.
(A) Companies with such structures may revise their capital structures
in order to provide for a sufficiently large class of capital instruments
that proportionally bear first losses in liquidation (that is, the
Class B interests in this example).
(B) Alternatively, companies with such structures
could revise their capital structure to ensure that all classes of
capital instruments that are intended to qualify as common equity
tier 1 capital share equally in losses in liquidation consistent with
criteria (i), (ii), (vii), and (viii) in section 217.20(b)(1)(i),
(ii), (vii), respectively, even if each class of capital instruments
has different rights to allocations of profits, as in paragraph (c)(4)
of this section.
(6) Mandatory
distributions.
(i) A partnership agreement contains
provisions that require distributions to holders of one or more classes
of capital instruments on the occurrence of particular events, such
as upon specific dates or following a significant sale of assets,
but not including any final distributions in liquidation.
(ii) Any class of capital
instruments that provides holders with rights to mandatory distributions
would not qualify as common equity tier 1 capital because a holding
company must have full discretion at all times to refrain from paying
any dividends and making any other distributions on the instrument
without triggering an event of default, a requirement to make a payment-in-kind,
or an imposition of any other restriction on the holding company (criterion
(vi) in section 217.20(b)(1)(vi)). Companies must ensure that they
have a sufficient amount of capital instruments that do not have such
rights and that meet the other criteria of common equity tier 1 capital,
in order to meet the requirements of Regulation Q.
(7) Features that reallocate prior distributions.
(i) An LLC issues two types of membership
interests, Class A and Class B. The terms of the LLC’s membership
interests provide that, under certain circumstances, holders of Class
A interests must return a portion of earlier distributions, which
are then distributed to holders of Class B interests (sometimes called
a “clawback”).
(ii)
If the reallocation of prior distributions described in paragraph
(c)(7)(i) of this section could result in holders of the Class B interests
bearing fewer losses on an aggregate basis than Class A interests,
the Class B interests would not qualify as common equity tier 1 capital.
However, where the membership interests provide for disproportionate
allocation of profits, such as described in the example in paragraph
(c)(4) of this section, and the reallocation of prior distributions
would be limited to reversing the disproportionate portions of prior
distributions, both the Class A and Class B interests could qualify
as common equity tier 1 capital provided that they met all the other
criteria in section 217.20(b).
