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BASEL III: The Final Rules are Here and It’s Time to Get Ready

August 14, 2013

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Over the past year, my colleagues and I have spent an untold number of hours researching, writing and speaking about the Basel III capital rules. We felt it important to help bankers focus on the proposed rules in order to help them prepare and to help facilitate an appropriate response to the proposed rules. Because the rules were in proposed form, however, many bankers, bank directors and industry participants did not focus on these capital rules, instead waiting until they were finalized. Well, we’re here.

Earlier this month, the regulatory agencies finalized their revisions to the capital and risk-weighting rules, commonly known as the Basel III rules. Even though the rules will not be effective for most banks until Jan. 1, 2015, the finalizing of these rules presents the call to action to begin the dialogue about how the new rules will impact your bank. Of course, given the fact that the final release for the rules was almost 1,000 pages long, many bankers contemplating a board presentation are left to ask, “Where should I start?” Below are a few suggested areas of focus to begin to enhance your directors’ understanding of the new rules. 

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Keys to Success in the FDIC’s Definition of Community Bank

July 10, 2013

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In a recent strategic planning meeting, a bank chairman opined that “community banking is dead.” He is not the only banker and his is not the only bank grappling with this concern. After that meeting, we solicited the input of many of our peers in the industry. Were increasing expenses and shrinking margins killing community banks? Was the ever-quickening pace of technology too much for community banks to overcome? Were the building regulatory demands insurmountable for community banks? As we asked our peers these questions, many of them gave multi-faceted answers based on different assumptions of exactly what was meant by “community bank.” 

Around the same time, the FDIC proposed its own definition of “community bank” as a part of its Community Banking Study, which was published in December 2012. This study not only defends the viability of community banks but also introduces a thought-provoking definition of exactly what constitutes a community bank. The definition includes a component related to size and a component related to core deposit gathering. It also includes components related to the number of offices and percentage of loans to assets. The focus of this article, however, is the following two criteria: 

  • simplicity of business plan; and 
  • operating within a limited geographic area.
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Wow! The Fed responds to comments from Community Banks on Basel III

July 2, 2013

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While the final Basel III capital rules have not been published at the time of this post, it was clear from this morning’s comments at the meeting of the Board of Governors of the Federal Reserve System that community banks have been heard. Highlights from the meeting include the following positions of the Federal Reserve on the Basel III rules.

  •  AOCI – Non-internationally active financial institutions (i.e., all community banks) will be allowed a one-time option to opt out of the inclusion of accumulated other comprehensive income in Tier 1 regulatory capital. This opt-out option will ease the potential burden on community banks from incorporating fluctuations in the value of their available for sale securities portfolio in their regulatory capital calculations. We view this as a big win for community banks.
  • Mortgage Loan Risk-Weighting – Many community banks expressed a great deal of concern with the proposed risk weighting of residential mortgage loans, which was based on loan-to-value ratios and certain other features, including whether or not the loan had a balloon feature. In response to those comments, the final Basel III rule will contain no changes to the current risk weighting of residential mortgage loans. While this is a nice win for banks and borrowers, the separate qualified mortgage rules will likely impact mortgage lending in the future.
  • Trust Preferred Securities – The final Basel III rules will grandfather the eligibility of trust preferred securities to qualify as Tier 1 capital for bank holding companies with less than $15 billion in total consolidated assets. This change will obviate the need for many community banks to raise capital through the issuance of common equity to replace the Tier 1 capital previously provided by the issuance of trust preferred securities.

While the written rule will undoubtedly contain a great deal of additional clarifications, the early comments from the meeting of the Board of Governors of the Federal Reserve System indicate that the rally of community banks against certain aspects of the Basel III rules was very successful. We will publish more analysis as we digest the final rules.

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The Bank Director’s Approach to M&A: Stay Out of Hot Water

November 30, 2012

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In today’s environment, many bank directors are faced with difficult strategic decisions regarding the future of their organizations. We have been involved in many great board discussions of whether it is best for the bank to continue to grind away at its business plan in this slow growth environment or to look for a business combination opportunity that will accelerate growth. There is rarely a clear answer in these discussions, but some guidelines are helpful: All directors must respect the conclusion of the full board of directors and follow the appropriate process established by the board with respect to merger opportunities.

Over the years, we have seen a number of instances in which one or more bank directors conduct merger discussions with potential partners without bringing the opportunity to the full board of directors immediately. In many cases, these directors are acting in good faith and simply leveraging relationships they have with other bankers or bank directors. In other cases, these directors may feel the need to engage in these discussions because they disagree with the full board’s strategy of remaining independent. However, all directors should understand that it is in the bank’s best interest, and the director’s own personal best interest, not to take matters into their own hands without authorization by the board of directors.

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Regulators Announce Delay in Adoption of Final Basel III Capital Rules

November 9, 2012

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Given the tremendous volume of comments from industry participants regarding the Basel III capital rules and the mounting political pressure regarding adoption of the rules, many industry observers had speculated that the Federal Reserve, FDIC, and OCC would be challenged to adopt the final rules before January 1, 2013 (the date established for effectiveness of portions of the rule in the release of the proposed rules). On November 9, 2012, the agencies announced that they indeed will not be able to meet that deadline.   This announcement runs contrary to the recently renewed directive by the Basel Committee on Banking Supervision for all members of the committee to adopt final rules prior to January 1, 2013. However, we believe it is appropriate for the U.S. regulatory agencies to carefully consider the impact of the rules on the U.S. banking system, particularly in light of our unique community banking system, and support the agencies delay in adopting the rules.

It is our understanding that the regulatory agencies are working through the comment letters submitted to them and are well aware of the concerns of community bankers, including the inclusion of unrealized gains and losses in the available-for-sale securities portfolio in Common Equity Tier 1 capital and the changes in risk-weighting for mortgage loans. We will continue to carefully monitor the progress of the rulemaking process as the agencies consider the impacts of the Basel III rules on the industry.

 

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OCC Releases Stress Testing Guidance for Community Banks

October 22, 2012

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On October 18, 2012, the OCC released stress testing guidance  for national banks and federal savings associations with $10 billion or less in total assets.  While the regulatory authorities clarified in May of this year that the Supervisory Guidance on Stress Testing for Banking Organizations with More than $10 Billion in Total Consolidated Assets would not apply to community banks, the OCC has now confirmed that the stress testing requirements in Dodd-Frank have “trickled down” to community banks, at least to those regulated by the OCC. The guidance states that appropriate stress testing should be performed at least annually.

Fortunately for community bankers, the stress testing guidance is greatly scaled back from the rules applicable to larger institutions, and the requirements are flexible in many respects. The guidance specifically states that the OCC does not specifically endorse any particular stress testing model and that banks with smaller scale and lesser complexity may be able to satisfy the requirements of the guidance by performing single spreadsheet analysis in some cases. This acknowledgement is in stark contrast to the onerous requirements applicable to larger banks, which can be read to require testing of all likely and unlikely scenarios using a wide variety of scenarios through the use of a number of different models.

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Georgia Banks Targeted for Alleged ATM Patent Infringement – Bryan Cave Mounts a Joint Response

August 23, 2012

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We have learned that a company, Automated Transactions, LLC, is now targeting banks throughout Georgia alleging patent infringement with respect to ATM technology.  This entity has also targeted banks in other states, including several New England states. Automated Transactions claims that it has exclusive rights to certain ATM technologies and that banks, through the use of their ATMs, are infringing upon those rights. A number of banks in Georgia have received a demand letter from Automated Transactions, and we understand that more banks in Georgia will be targeted. We want banks to understand the issue being raised and be prepared to respond.  Please click here for a Bryan Cave memo that analyzes the allegations being made. 

In order to respond to these allegations effectively, we believe Georgia banks should undertake a concerted response.  If attacking the merits of the patents, we expect that there would be numerous issues on which banks would share a position. If licensing discussions were to be pursued, Georgia banks will have more bargaining leverage working as a group. In any event, the more banks involved, the greater the impact they can have in any discussions and the smaller the cost per bank.

To that end, we are currently working with approximately two dozen Georgia banks in responding to these patent infringement allegations. If you are contacted by this claimant and/or want to obtain more information about joining the group, please contact Walt Moeling (404-572-6629), Jonathan Hightower  (404-572-6669), or Ryan Pumpian (404-572-6851).

 

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Agencies Extend Comment Period on Regulatory Capital Proposals

August 8, 2012

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On August 8, 2012, the banking regulators (Federal Reserve, OCC, and FDIC) extended the comment period on the three notices of proposed rulemaking that implement the Basel III capital standards and revised risk-weighting rules. Many organizations representing community banks had requested more time for community banks to analyze the impact of those proposed rules on their operations, and the regulatory agencies have responded to those requests.

The deadline for submitting comments is now October 22, 2012 (comments had been due on September 7, 2012). We recommend that community banks carefully analyze the impact of the proposals on their balance sheets and business plans and submit comments as appropriate. These comments are key in the effort to effect change in the final rules. We have heard from many bankers that they are concerned about the new rules’ impact on a wide variety of facets of their banks, including mortgage lending, real estate lending, and the structure of their securities portfolios.

Please contact any member of the Bryan Cave financial institutions team if you would like to discuss the impact of the rules on your bank or if you need help drafting your comment letter.

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TARP CPP Securities and the Bank Holding Company Act

July 23, 2012

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In connection with the contemplated pooled auction of TARP CPP securities, Treasury has explicitly reminded potential participants that purchasers are responsible for compliance with the Bank Holding Company Act of 1956, as amended.  The Form of Bid Letter includes a representation that each bidder is “aware of the potential implications of a purchase of any CPP securities under the Bank Holding Company Act, in particular, with respect to holding certain percentages of “voting securities” or more than one third of a financial institutions total equity.”

These statements have led to a number of questions regarding the impact of the Bank Holding Company Act vis-a-vis the TARP CPP securities.

We understand that the Federal Reserve Board is considering providing updated guidance specific to the CPP securities, but the contents of that guidance have not been finalized.

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New Basel III Capital Rules Contain Pitfalls for S Corporation Banking Organizations

July 17, 2012

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As the industry gains a greater understanding of the proposed Basel III capital rules, some management teams are identifying potential problems for their organizations in the rules. One such problem is the broad-based dividend restrictions and the consideration of how those restrictions may impact S Corporations.

Many states recognize in their banking laws and regulations that a different set of standards should apply in determining dividend restrictions for S Corporation banking institutions and their holding companies. Because the taxable income of these entities is passed through to the shareholders of the organization, it is expected that these entities will pay distributions that allow their shareholders to fund their personal tax liabilities attributable to the taxable income of the organization.

The proposed Basel III capital rules have a number of dividend restrictions. Most bankers are familiar with the dividend restrictions imposed under Prompt Corrective Action, but the new capital rules also contain dividend restrictions if the organization is not in full compliance with the requirement to maintain the required capital conservation buffer: a requirement for banking organizations to maintain common equity Tier 1 capital equal of 2.5% of total risk-weighted assets in addition to the minimum risk-based capital requirements.

If a banking organization does not maintain the full capital conservation buffer, it becomes subject to restrictions on the payment of dividends and on payments of discretionary bonuses to executive officers. These restrictions increase as the organization’s capital conservation buffer decreases, and if the organization does not maintain a capital conservation buffer of at least 1.25% of risk-weighted assets, it will be able to pay dividends of no more than 20% of its eligible retained income in dividends, subject to receiving a waiver of these restrictions from its regulators. Eligible retained income is defined as the organization’s net income for the previous four quarters, net of dividends and discretionary bonus payments to executive officers during that period.

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