U.S. Bank Plan Hits Snag in Rules

The Office of the Comptroller of the Currency said it was committed to ensuring that banks can count Treasury's investments as core capital. "Any preferred shares issued to Treasury under this program will count," said spokesman Robert Garsson.

The first nine participating banks all are regulated by the Federal Reserve. Treasury officials said the department could make the first round of investments early next week in the companies, including Bank of America, Goldman Sachs and Citigroup.

If other regulators do not change their rules, however, it could jeopardize the government's broader plan for investing in potentially thousands of smaller banks. The uncertainty surrounding the plan, and the slow pace of the changes, is a frustration to banks eager for clarity and money.

Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, said the accounting issues "are continuing to slow the recovery effort."

Each banking regulator sets its own rules for the institutions it oversees, including rules dictating how much core capital an institution must hold -- measured as a percentage of its loans and other commitments -- and what kinds of money can be counted. In general, core capital includes money banks do not need to repay, such as funds raised by selling shares of common stock.

Traditionally, banking regulations excluded the kind of preferred shares that banks would sell to Treasury.

The Fed's longstanding rules, for example, excluded from core capital shares that pay a stepped interest rate, meaning that the yield on the shares increases after a fixed period of time. The shares issued to Treasury would pay 5 percent for five years and 9 percent thereafter.

Banking regulators historically have been concerned that the increase in interest payments made such shares a volatile source of capital because it increased the chances that a bank would decide to repay the shareholders' investments. That is the explicit purpose of the stepped interest rate in the Treasury plan.

Such an investment can also interfere with a bank's ability to raise money from other sources because the bank has an obligation to make dividend payments first to the preferred shareholders, potentially limiting payments to common shareholders.

In changing the rules, the Fed noted that its traditional concerns were mitigated by the fact that the terms of the Treasury investment allow the Fed to prevent a bank from selling its shares, and on the other hand that the terms of the investment encourage banks to raise private capital to replace the shares.

The Fed also noted that the plan was designed "to help achieve a fundamental public policy objective in the United States."

Treasury also is in discussions with the Securities and Exchange Commission to change another accounting rule that may make the investment plan less attractive to banks.

The plan requires banks that accept government money to hand over warrants, which would give Treasury the contractual right to shares of their common stock. The measure was intended to give taxpayers some upside if the banks recover and their shares rise.

But under current SEC rules, as share prices rise, banks would have to treat the gains as a projected expense, reflecting the cost to the company if the government decides to exercise its warrants.

Treasury is seeking to change that rule, sources familiar with the matter said.

"We're aware of the issue and are working with the SEC to address it," McLaughlin said.