July 31, 2013

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Key Elements of the New Capital Rules

The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency adopted the much anticipated new capital rules implementing Basel III.  The new rules will become effective for community banks on January 1, 2015, with many provisions of the new rules phasing in over a four-year period. This series will discuss the following:

• Part I. Overview  |  Entities Affected By The New Capital Rules
• Part II. Changes To The Minimum Capital Requirements
• Part III. Revised Regulatory Capital Calculation
• Part IV. Changes To The Risk-Weighting Of Assets
• Part V. The Impact Of The Capital Conservation Buffer

Steps You Can Take To Prepare For The New Capital Rules

• Educate your directors, executive team and financial staff on the new capital rules
• Prepare models to determine compliance with the new capital ratios
• Implement a stress test program scaled to your organization’s size and complexity
• Evaluate compensation packages in light of the capital conservation buffer

Part I. Overview  |  Entities Affected By The New Capital Rules

The new capital rules apply to, among others, all banks—regardless of whether they are state member, state non-member or national banks—thrifts and certain covered thrift holding companies and to bank holding companies with total assets of $500 million or greater.

Point Of Interest
Holding companies with total assets of less than $500 million and certain thrift holding companies will not be subject to the new capital rules, although they will apply toward the subsidiary bank. Various legislation is currently pending in Congress that – if passed – would provide some relief to community banks from the new capital rules.

Part II. Changes To The Minimum Capital Requirements

As a result of these rule changes, banks and bank holding companies must maintain higher minimum capital ratios and prepare for maintaining a completely new capital requirement.  In addition to Tier 1 and Tier 2 capital levels, the rules introduce the Common Equity Tier 1 capital ratio.  The higher minimum required ratios also establish new thresholds for prompt corrective action triggers.  The new minimum capital ratios, including Common Equity Tier 1, are set forth below.

Part III.  Revised Regulatory Capital Calculation

The regulatory agencies designed the new capital rules to improve capital quality by reducing a bank’s ability to rely on non-common stock instruments previously permissible for inclusion in Tier 1 capital.  Consistent with this design, the new rules implement stricter eligibility requirements for regulatory capital instruments.  For example, bank holding companies with more than $15 billion in assets must phase out their trust preferred securities from their Tier 1 capital.  

Bank holding companies with less than $15 billion in assets, however, may continue to include any trust preferred securities issued before May 19, 2010 as Tier 1 capital, provided all hybrid securities, including trust preferred securities, cannot make up more than 25% of the institution’s Tier 1 capital.  The new rules also change how minority interests, deferred tax assets, mortgage-servicing assets and certain capital investments are included in capital.

Point Of Interest
Smaller banking organizations are allowed a one-time option to filter certain Accumulated Other Comprehensive Income (“AOCI”) components.  The AOCI opt-out must be made on the institution’s first Call Report on FR Y-9C or FR Y-9SP, as applicable, filed after January 1, 2015.

Part IV.  Changes To The Risk-Weighting Of Assets

The new capital rule also increases the risk-weightings for certain assets, including commercial real estate loans, past due loans and equity exposures.  These revisions were intended to harmonize the agencies’ rules for calculating risk weights and to fix certain weaknesses identified over recent years.  The changes to risk-weighting are extensive and are beyond the scope of this initial Client Alert; however, we will provide additional information on the new risk-weightings in the fifth installment of this series.

Part V. The Impact Of The Capital Conservation Buffer

In addition to the higher capital requirements, the new rules require that institutions maintain a capital conservation buffer comprised of Common Equity Tier 1 capital of 2.5% over each minimum risk-based capital ratio in order to avoid limitations on capital distributions, including dividends and discretionary bonuses.  The limitations are on a sliding scale such that as the capital conservation buffer decreases the percentage of retained income that may be distributed also decreases.  The capital conservation buffer will be phased-in between 2016 and 2019.  

Point Of Interest
S-corporations are not exempt from the requirement to maintain the capital conservation buffer, and their ability to issue a tax dividend may be limited if the buffer is not maintained.

Resources

As with any new rulemaking, implementation of the required changes and thorough planning for the impact of new concepts will take time.  We urge you to begin the process of understanding how these rules will impact your organization as soon as possible.  To aid in this understanding, we have provided links to the following useful regulatory guidance for community banks:

• Interagency New Capital Rule Community Bank Guide

• http://www.federalreserve.gov/bankinforeg/basel/files/capital_rule_community_bank_guide_20130709.pdf

• OCC New Capital Rule Quick Reference Guide for Community Banks

• http://www.occ.gov/news-issuances/news-releases/2013/2013-110c.pdf

• Expanded Community Bank Guide to the New Capital Rule for FDIC Supervised Banks

• http://www.fdic.gov/regulations/capital/Community_Bank_Guide_Expanded.pdf

Please feel free to contact us with any questions concerning the new capital rules or any other issues.