CAPITAL PLANNING ISSUES

 

Here are several issues that will impact your capital planning as your look over the next five year planning horizon.

  1. FDIC adopts final rule on optional Community Bank Leverage Ratio (9/17/2019) CBLR Compliance Guide (10/29/2019)

    FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations. The Community Bank Leverage Ratio (CBLR) framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. The CBLR framework will be available for banks to use in their March 31, 2020, Call Report. The CBLR Compliance Guide issued on 10/29 did not specify the method for opting-in through the filing of the Q1 2020 Call Report. There was no specific mention of a checkbox to opt-in. Nor did it clearly state that completing or not completing the risk-based capital data elements in the Call Report would trigger opt-in. The FDIC issued a compliance guide on October 29 to accompany the rule. Effective date is Q1 2020.

    Link to: CBLR Fact Sheet. Link to: Final CBLR Rule. Link to: CBLR Rule and Deposit Insurance Assessment. Link to CBLR Compliance Guide.

  2. Agencies adopt final rule to exclude community banks from the Volcker Rule (7/9/2019)

    Regulatory agencies adopted a final rule to exclude community banks from the Volcker Rule, consistent with the Economic Growth, Regulatory Relief, and Consumer Protection Act. The Volcker Rule generally restricts banking entities from engaging in proprietary trading and from owning, sponsoring, or having certain relationships with hedge funds or private equity funds. Under the final rule, which is unchanged from the proposal, community banks with $10 billion or less in total consolidated assets and total trading assets and liabilities of 5 percent or less of total consolidated assets are excluded from the Volcker Rule.

  3. Agencies simplify regulatory capital rules (7/9/2019)

    Regulatory agencies issued a final rule that reduces regulatory burden by simplifying several requirements in the agencies' regulatory capital rules. The final rule simplifies the capital treatment for mortgage servicing assets, certain deferred tax assets, investments in the capital instruments of unconsolidated financial institutions, and minority interest. Under current rule, mortgage-servicing assets, deferred tax assets, and investments in financial institutions are in aggregate limited to 15 percent of CET1 and 10 percent of CET1 individually. Under the final rule, the aggregate “15 percent of CET1” limit is eliminated and the individual thresholds are increased to 25 percent of CET1. The final rule also would allow bank holding companies and savings and loan holding companies to redeem common stock without prior approval unless otherwise required. Proposed revisions to the definition of high-volatility commercial real estate exposure, which were made in the notice of proposed rulemaking, are being addressed in a separate rulemaking. The final rule will be effective as of April 1, 2020, for the amendments to simplify capital rules.

    Link to DavisPolk summary and memo on these simplification changes.

    Impact to Community Banks: Additional data on impact to Community Banks (i.e., less than $10 billion in Total Assets):

    • 67% of Community Banks reported no MSRs in Q1 2019;

    • Additional 21% of Community Banks fell under the original 10% of CET1 threshold; and

    • An additional 10% of Community Banks will fall under the new 25% of CET1 threshold.

    • In total, 98% of Community Banks will fall under the 25% of CET1 threshold.

  4. Agencies Allow Three-Year Regulatory Capital Phase In for New Current Expected Credit Losses (CECL) Accounting Standard (12/21/2018)

    Final Rulemaking modifying their regulatory capital rules and providing an option to phase in the new accounting standard for credit losses, known as "Current Expected Credit Losses" (CECL) methodology. The final rule allows banking organizations to phase in the day-one regulatory capital effects of CECL adoption throughout three years. The final rule also revises the agencies' regulatory capital rule and other rules to reflect the new accounting standard.

Recent Regulatory Developments:


Text Example

Updated to add FINAL RULE ISSUED 9/17/2019; EFFECTIVE DATE Q1 2020.

Community bank leverage ratio proposal:

The federal banking regulators have issued a final rule for implementing the new Community Bank Leverage Ratio as required under Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act.

Under the final rule, a community banking organization would be eligible to elect the community bank leverage ratio framework if:

  • Less than $10 billion in total consolidated assets

  • Total off-balance sheet exposures < 25% of total assets

  • Total trading assets and liabilities < 5% of total assets

  • Limited amounts of certain assets such as deferred tax assets, and

  • Community Bank Leverage Ratio (CBLR) greater than 9 percent.

A qualifying community banking organization that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements. Such a community banking organization would be considered to have met the capital ratio requirements to be well capitalized for the agencies’ prompt corrective action rules provided it has a CBLR greater than 9 percent.

Press Release (9/17/2018) - FDIC

CBLR - FINAL RULE ISSUED (9/17/2019)

CBLR Fact Sheet FDIC

Calculation of the CBLR:

CBLR = Tier 1 Capital divided by Average Total Consolidated Assets

Key considerations by federal banking regulators in designing CBLR framework:

  1. CBLR framework is intended to be available to a meaningful number of well capitalized banking organizations with less than $10 billion in total consolidated assets.

  2. CBLR should be calibrated to not reduce the amount of capital currently held by qualifying community banking organizations.

  3. Federal bank regulatory agencies intend for banking organizations with higher risk profiles to remain subject to the generally applicable capital requirements to ensure that such banking organizations hold capital commensurate with the risk of their exposures and activities.

  4. Federal bank regulatory agencies would maintain the supervisory actions applicable under the PCA (Prompt Corrective Action) framework and other statutes and regulations based on the capital ratios and risk profile of a banking organization.

  5. CBLR framework is intended to provide meaningful regulatory compliance burden relief and be relatively simple for banking organizations to implement.

Today many Community Banks hold capital at levels that will meet or exceed the requirements under this final rule while also exceeding the current capital regulations significantly. However, under the CBLR final rule, a Community Bank will be committing to holding this higher level of capital.

If a Community Bank already exceeds this minimum, why not simply designate that you will operate under this new final rule?

Key questions or issues for consideration before you make this election at the time of filing your first quarter 2020 Call Report:

  1. What is the cost burden of complying with the current risk-based capital rules?

  2. Will you need any of the excess levels of capital (i.e., above current capital rule requirements) in the future for balance sheet growth, acquisitions or returning capital to shareholders?

  3. How difficult or costly will it be to opt back out of the CBLR framework at a later date?

The final rule commits community banks to carry higher capital levels of 9.0% relative to Prompt Corrective Action Tier 1 Leverage Ratio of 5.0% for “Well Capitalized” achievement. While the simplicity of this approach may be beneficial, an important consideration is whether this CBLR final rule becomes a constraint on your capital management flexibility.

 

Analytical Comparison: While simplistic, a quick means to assess whether a Community Bank should take advantage of the CBLR election is to compare the cost burden of risk-based capital compliance to leveraging the additional CBLR capital with earning assets.

Assume a Community Bank had $25 million in Total Assets and a Tier 1 Leverage Ratio of 11%. This results in compliance with the CBL Ratio framework with a 2% cushion.

If this Community Bank were to grow its balance sheet such that its Tier 1 Leverage Ratio would be 9%, it would add another $5.5 million in Total Assets. If it earned a pre-tax R.O.A. of 1.5%, it would earn another $68 thousand in pre-tax income.

The trade-off proposed for opting in to the CBL Ratio framework would be the cost of calculating and reporting the risk-based capital framework compared to the additional earnings of $68 thousand from balance sheet growth.

Does a $25 million Community Bank spend over $68 thousand annually in compliance of risk-based capital reporting? As the size of the Community Bank increases, this opportunity cost rises. For a $500 million total asset Community Bank, the opportunity cost increases to $1.7 million. Does a Community Bank of this size spend that much on risk-based capital compliance and reporting?

 

The federal banking regulatory agencies have established the initial Community Bank Leverage Ratio (CBLR) at 9.00%. In this bar chart, the green shaded bars show the number of Community Banks that would achieve this minimum level. The red shaded bars show those Community Banks that would not meet this proposed threshold.

This table estimates Community Bank Leverage Ratio for various size banks by total assets within 25 bps increments from 8.00% to 10.00%.

This table estimates the extra capital to be held above the 10.5% Total Capital Ratio minimum under the current capital rules and the 5.0% Leverage Ratio minimum under Prompt Corrective Action rules.


How does your 2019 or Long Term Planning Scenarios stack up against the Fed's Capital Stress Testing Scenarios?

 

GDP: Base Case has GDP growing on average 2.0%. Adverse Case assumes mild recession with GDP down 2.7% followed by a solid recovery. Severely Adverse Case has harsher recession with GDP dropping 7.8%. followed by a strong recovery.

Unemployment Rate; Base Case has Unemployment Rate remaining low in 3.8% to 4.1% range. Adverse Case assumes mild recession with Unemployment Rate peaking at 7.0%. Severely Adverse Case has harsher recession with Unemployment Rate rising to 10.0%.

3-month U.S. Treasury Yield: Base Case has 3-month US Treasury rising 50 bps to 2.8%. Adverse Case assumes mild recession with 3-month US Treasury dropping to 0.1%. Severely Adverse Case has harsher recession with 3-month US Treasury dropping to 0.1%.

5-year U.S. Treasury Yield: Base Case has 5-year US Treasury rising 60 bps to 3.4%. Adverse Case assumes mild recession with 5-year US Treasury immediately plummeting to 0.5% before recovering to 1.3%. Severely Adverse Case has harsher recession with 5-year US Treasury dropping to 0.3% and recovering to 1.2%.

10-year U.S. Treasury Yield: Base Case has 10-year US Treasury rising 60 bps to 3.6%. Adverse Case assumes mild recession with 10-year US Treasury immediately plummeting to 0.8% before recovering to 1.9%. Severely Adverse Case has harsher recession with 10-year US Treasury rate also falling to 0.8% before rising to 1.8%.

U.S. Treasury Yield Curve Slope (10-year minus 3-month): Base Case has slope narrowing to 40 before recovering to 80 bps. Adverse Case assumes mild recession with slope rising to 180 bps. Severely Adverse Case has harsher recession but with slope only rising to 170 bps.

Mortgage Rate: Base Case has Mortgage Rate rising 50 bps to 5.1%. Adverse Case assumes mild recession with Mortgage Rate immediately plummeting to 3.5% and holding near this level. Severely Adverse Case has harsher recession with Mortgage Rate volatile until declining 3.5%.

Mortgage Rate Spread to 10-year U.S. Treasury: Base Case has spread flat at 150 bps. Adverse Case assumes mild recession with widening to 260 bps before recovering to 170 bps. Severely Adverse Case has harsher recession with widening to 340 bps before declining back to 170 bps.

BBB Corporate Bond Yield: Base Case has BBB bond yield rising only 20 bps to 5.2%. Adverse Case assumes mild recession with BBB bond yield falling to 3.7%. Severely Adverse Case has harsher recession with BBB bond yield rising to 6.5% before declining back to 3.7%.

BBB Bond Yield Spread to 10-year U.S. Treasury Yield: Base Case has spread flat at 160 to 170 bps. Adverse Case assumes mild recession with widening to 370 bps before recovering to 190 bps. Severely Adverse Case has harsher recession with widening to 550 bps before declining back to 190 bps.

DJIA: Base Case has DJIA rising 4.6% annually on average. Adverse Case assumes mild recession with DJIA falling 22% to near 20,000 before recovering to above 25,000. Severely Adverse Case has harsher recession with DJIA falling 50% to under 13,000 before recovering to above 25,000.

VIX Index: Base Case has VIX generally stable. Adverse Case assumes mild recession with VIX jumping to 44 before recovering to above 20. Severely Adverse Case has harsher recession with VIX rocketing 2X to 70 before recovering to 20.

Housing Prices: Base Case has HPI rising 2.7% annually on average. Adverse Case assumes mild recession with HPI falling 14% before recovering. Severely Adverse Case has harsher recession with HPI falling 26% before recovering.

Commercial Real Estate Prices: Base Case has CREI rising 4.5% annually on average. Adverse Case assumes mild recession with CREI falling 18% before recovering. Severely Adverse Case has harsher recession with CREI falling 35% before recovering.