By Richard A. Roth, J.D.
The Office of the Comptroller of the Currency has replaced its guidance on subordinated debt issuance with new guidelines that apply to all subordinated debt of national banks and federal savings associations. It also replaced its sample national bank subordinated debt note with two samples, one to be used if the debt is to be included in regulatory capital and the other for debt that will not be included. However, the sample forms apply only to national banks. Forms for federal thrifts are to be issued in the near future, the OCC says (OCC 2015-22).
Simply put, subordinated debt is debt that in the case of a financial institution’s default or insolvency will not be repaid until all senior debt has been repaid. If a national bank or federal thrift wants to issue subordinated debt, it must satisfy the requirements of the appropriate regulations (12 CFR 5.47 and12 CFR 163.80, respectively). These include not including impermissible terms, making required disclosures, and satisfying restrictions on maturity and prepayment terms.
According to the OCC, banks and thrifts that issue subordinated debt generally want to include it in their tier 2 regulatory capital. In that case, more stringent requirements must be met, beginning with giving the OCC prior notice. Sometimes subordinated debt is issued for funding or liquidity purposes, in which case the higher requirements do not apply; however, the regulations and guidance remain applicable. The guidelines apply to all subordinated debt issued on or after April 3, 2015.
General requirements. The guidelines set out a number of restrictions on all subordinated debt that supplement the requirements of the regulations. For example:
- Representations and warranties may not permit the acceleration of the debt and trigger repayment obligations if the default is based on a change in the financial institution’s status, its default on another agreement, or a violation of its articles of incorporation. Acceleration should be based only on credit-related issues.
- Affirmative covenants may not require an institution improperly to disclose non-public OCC information and must require that financial information be protected from public disclosure by a confidentiality agreement.
- Negative covenants may not unreasonably restrict an institution’s ability to carry out its business or unduly interfere with management. (Examples of banned covenants are given in 12 CFR 5.47.)
- Events of default should not include “minor, insignificant, or nonconsequential events” unless the institution has at least been given a reasonable chance to cure.
- Contemporaneous loan agreements between the institution’s holding company and a third-party lender, which sometimes are used to fund subordinated debt purchases, must be reviewed to ensure they do not require the holding company to induce the bank to violate the guidelines.
- Significant early redemption incentives for the bank are not permitted. The guidelines make no effort to provide a list of such terms, but they explicitly warn against preplanned coupon rate increases.
- Credit-sensitive features that would adjust the coupon rate based on changes in the issuer’s credit standing are banned.
- Raising expectations that a call option will be exercised also is banned. A subordinated debt note’s terms may permit the bank or thrift to call the note after five years, but the issuer may not, when marketing or selling the note, make any statements about future redemption plans.
- Subordinated debt purchase funding may not be provided by the issuing bank or thrift or by any entity the issuer controls.
- A subordinated debt issuer other than the bank or thrift, or an operating entity of the bank or thrift, then the issuer must be an operating entity whose only asset is its investment in the bank’s or thrift’s capital. Also, the proceeds of the issuance must be immediately available, without limitation, to either the financial institution or its holding company.
