CAPITAL PLANNING ISSUES
Here are several issues that will impact your capital planning as your look over the next five year planning horizon.
Updated to add final Notice of Proposed Rulemaking and final due date - April 9, 2019 - for comments.
Community bank leverage ratio proposal:
The federal banking regulators have issued a proposal for comment on implementing the new Community Bank Leverage Ratio as required under Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (May 2018).
Under the proposal, 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.
CBLR Notice of Proposed Rulemaking (Note: NPR finally issued 2/2/2019)
Due date for comments: April 9, 2019
Calculation of the CBLR:
CBLR = Tangible Equity Capital divided by Average Total Consolidated Assets
Key considerations by federal banking regulators in designing CBLR framework:
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.
CBLR should be calibrated to not reduce the amount of capital currently held by qualifying community banking organizations.
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.
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.
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 proposal while also exceeding the current capital regulations significantly. However, under the CBLR proposal, 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 proposal?
Key questions or issues for consideration before you make this election:
What is the cost burden of complying with the current risk-based capital rules?
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?
How difficult or costly will it be to opt back out of the CBLR framework at a later date?
The proposal commits community banks to carry 2 to 3 percentage points of higher capital levels. While the simplicity of this approach may be beneficial, an important consideration is whether this CBLR proposal 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 returning capital to shareholders (or another alternative is to leverage the additional CBLR capital with earning assets).
If a Community Bank were to dividend excess capital to shareholders, there would be a loss of interest income from the earning assets that are liquidated. Let’s assume that this yield = 3.50%. And let’s assume that the Community Bank can dividend up capital equal to 2% of total assets rather than committing to hold that extra capital under the CBLR proposal. For a $25 million total asset Community Bank, this results in lost income of approximately $18 thousand ($500 thousand in excess capital times opportunity cost of 3.50%). Does a $25 million Community Bank spend over $18 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 $350 thousand. Does a Community Bank of this size spend that much on risk-based capital compliance and reporting?
Final Phase-in of Capital Rules Occurs January 1, 2019.
How does your 2019 or Long Term Planning Scenarios stack up against the Fed's Capital Stress Testing Scenarios?