January 25, 2002

January 25, 2002

ABA SECURITIES ASSOCIATION:

HIGHLIGHTS OF EQUITY INVESTMENT CAPITAL RULE

Set forth below, in brief outline form, are the highlights of the banking agencies’ recently released final rule governing the regulatory capital treatment of equity investments by banking organizations. In general, the rule requires a deduction from a banking organization’s Tier 1 capital depending on the amount of covered equity investments held by the organization -- and as the amount of such investments increases as a percentage of the organization’s Tier 1 capital, the marginal rate for calculating the deduction also increases. The rule takes effect on April 1, 2002. I. Deduction for Nonfinancial Equity Investments -- General Rule in Table Form

Aggregate adjusted carrying value of all nonfinancial equity investments held directly or indirectly by the banking organization (as a percentage of the Tier 1 capital of the banking organization) Less than 15 percent 15 percent to 24.99 percent 25 percent and above II.

Equity Investments Fully Subject to Rule A.

Only those equity investments that are (i) nonfinancial; (ii) made pursuant to the following five sources of legal authority; and (iii) made after March 13, 2000: 1. 2. 3. 4. 5.

Merchant banking investments (§ 4(k)(4)(H) of BHCA) 5 percent investments (§§ 4(c)(6) or 4(c)(7) of BHCA) Reg K portfolio investments (12 C.F.R. § 211.8(c)(3)) SBIC investments exceeding 15% of capital

State bank equity investments (§ 24 of FDI Act (other than under § 24(f))

Deduction from Tier 1 Capital (as a percentage of adjusted carrying value of investment) 8 percent 12 percent 25 percent

III.

Equity Investments Partly Subject to Rule A.

Two types of equity investments: 1. 2.

Nonfinancial SBIC investments totaling less than 15% of Tier 1 capital Investments that are (1) nonfinancial; (ii) made pursuant to the 5 sources of legal authority described above; and (iii) made before March 13, 2000 (“grandfathered investments”)

B. C.

Neither SBIC investments under 15% of capital nor grandfathered investments are subject to the rule’s capital deduction

But, the aggregate adjusted carrying value of both types of investments counts for purposes of determining the appropriate capital deduction category (8%, 15%, or 25%) that applies to other covered investments -- which could bump such other investments into a higher deduction category than would otherwise be the case. 1.

E.g., assume a banking organization holds nonfinancial SBIC investments equal to 15% of Tier 1 capital, and covered equity investments equal to 5% of Tier 1 capital. The SBIC investment would be subject to no capital deduction, while the covered investment would be subject to a 12% deduction. If the rule did not count the SBIC investment in determining the appropriate deduction category, then the covered investment would only have been subject to an 8% deduction.

IV. Equity Investments Not Subject to Rule A. B.

Exclusively financial equity investments Following nonfinancial equity investments: 1. 2. 3. 4. 5. 6.

Investments from satisfaction of Debt Previously Contracted (DPC) State bank investments under §24(f) of FDI Act

Investments in community development corps. (12 U.S.C. §24 (Eleventh)) Unexercised warrants acquired by bank as consideration for loan (where not held under one of five legal authorities described in section II, above) Insurance affiliate investments (§ 4(k)(4)(I) of BHCA) Equity securities held as bona fide hedge of an equity derivative

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7. 8. 9.

V.

Equity securities held under authority to underwrite, deal in, or make a market in securities (§§ 4(k)(4)(E) and 4(c)(8)of BHCA Investments under \"complementary\" authority (§ 4(k)(1)(B) of BHCA)1 Nonconvertible senior or subordinated debt

Definition of \"Equity Investment\" A.

Any equity instrument (including common stock, preferred stock, partnership

interests, interests in limited liability companies, trust certificates and warrants and call options that give the holder the right to purchase an equity instrument) Any equity feature of a debt instrument (such as a warrant or call option) Any debt instrument that is convertible into equity

An investment in any other instrument (including subordinated debt) may be treated as equity if the agency determines that the instrument is the functional equivalent of equity

B. C. D.

VI. Definition of “Aggregate Adjusted Carrying Value” A.

Aggregate value at which investment is carried on balance sheet reduced by any unrealized gains on those investments that are reflected in such carrying value but are excluded from Tier 1 capital and associated deferred tax liabilities.

VII. Applicable to Risk Based Capital and Leverage Ratio A.

Deduction from Tier 1 capital applies with respect to calculation of both risk-based capital ratios (capital to total risk-adjusted assets) and leverage ratios (capital to total assets)

VIII. Deduction Also Applies for Other Purposes

A.

Deductions from Tier 1 capital also apply to other regulatory requirements that are geared to the amount of Tier 1 capital held by a banking organization, such as the covered transactions limit of § 23A of the Federal Reserve Act and the loan-to-one-borrower limit.

1

Could be subject to capital deduction based on case-by-case review.

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