On June 9, 2019, the federal banking agencies released a final rule to simplify aspects of the regulatory capital rules for banking organizations that are not “advanced approaches” banking organizations, i.e., those with less than $250 billion in total consolidated assets and less than $10 billion in total foreign exposure. Initially proposed in September 2017 as part of the agencies’ ongoing efforts to meaningfully reduce regulatory burden on small and mid-sized banking organizations, the final rule is intended to simplify and clarify certain aspects of the capital rules, and in particular the capital treatment of mortgage servicing assets, certain deferred tax assets, investments in the capital instruments of unconsolidated financial institutions, and minority interests. Importantly, the Board of Governors of the Federal Reserve System (“Board”) also used the rulemaking as an opportunity to streamline an important aspect of its regulatory framework by permitting bank holding companies, savings and loan holding companies, and state member banks of all sizes to redeem or repurchase their common stock without obtaining formal, prior regulatory approval under most circumstances.

Under the existing capital rules, a criterion for a common stock instrument to qualify as common equity Tier 1 capital is that the instrument “can only be redeemed via discretionary repurchases with the prior approval of the Board.” The Board and Federal Reserve Banks had interpreted this criterion to require holding companies to obtain prior approval for any redemption or repurchase of common stock, in any amount and in all circumstances. This interpretation rendered superfluous other laws and regulations that require prior approval for redemptions and repurchases only in specific circumstances and amounts where those actions raise safety and soundness and/or capital adequacy concerns.

For Board-regulated institutions, the capital simplification final rule amends that common equity Tier 1 criterion to provide that a qualifying instrument “can only be redeemed via discretionary repurchases with the prior approval of the Board to the extent otherwise required by law or regulation” (emphasis added). Examples of laws and regulations that may separately require Board approval for certain redemptions and repurchases include the capital conservation buffer, countercyclical capital buffer, G-SIB surcharge, capital plan rule, and Regulation Y’s requirement to obtain prior approval if a bank holding company’s stock repurchases and redemptions over a 12 month period equal or exceed 10 percent of the company’s consolidated net worth. The final rule’s change to the common equity Tier 1 criteria becomes effective as of October 1, 2019, but any banking organization may elect to adopt the change earlier, meaning that the rule’s additional flexibility in this area is available to Board-regulated institutions immediately.

Notably, the final rule does not discuss or address the Board’s existing regulatory guidance on the payment of dividends, stock redemptions, and stock repurchases, SR Letter 09-4, and in particular its application to ordinary course redemptions and repurchases. SR 09-4 states that a holding company subject to that guidance should inform Federal Reserve supervisory staff of a redemption or repurchase of common stock in several scenarios, including any buyback that results in a net reduction of the company’s outstanding amount of common stock below the amount outstanding at the beginning of the fiscal quarter. Such notice is intended to provide “reasonable opportunity for supervisory review and possible objection should Federal Reserve supervisory staff determine a transaction raises safety and soundness concerns,” and thus the letter would appear to continue to impose, as a supervisory matter, a de facto prior review and non-objection process for a wide range of ordinary course share buybacks by a holding company subject to the letter, notwithstanding last week’s change to the capital rule itself. The supervisory review and non-objection process described in SR 09-4 is difficult to reconcile with the Federal Reserve and other banking agencies’ more recent Interagency Statement Clarifying the Role of Supervisory Guidance, which affirms that guidance such as SR 09-4 does not have the force and effect of law and the agencies do not take enforcement actions on the basis of supervisory guidance.