In connection with the effectiveness of BASEL III, most banks are required to decide whether to elect to opt-out of the inclusion of Accumulated Other Comprehensive Income (“AOCI”) in their Common Equity Tier 1 Capital. All non-advanced approaches institutions (i.e. banks less than $250 billion in total assets with less than $10 billion in on-balance sheet foreign exposure) will need to indicate whether they are making the AOCI opt-out in their March 31, 2015 Call Reports. This is a one-time election and generally irrevocable, except in the limited cases of subsequent mergers between institutions with different elections.
As a reminder, AOCI includes such items as unrealized gains and losses on certain securities.
For institutions that opt out, most AOCI items will not be included in the calculation of Common Equity Tier 1 Capital (and thus Tier 1 Capital generally). In other words, most AOCI items will be treated, for regulatory capital purposes, in the same manner in which they were prior to BASEL III. (Unrealized gains and losses on available-for-sale debt securities will continue to be excluded from regulatory capital; unrealized losses on available-for-sale equity securities will continue to be recognized in regulatory capital; and up to 45% of unrealized gains on available-for-sale equity securities will continue to be recognized in Tier 2 capital.)
For institutions that do not opt out, most AOCI items will be included in the calculation of Common Equity Tier 1 Capital (and thus Tier 1 Capital generally). (Unrealized gains and losses on available-for-sale debt and equity securities will be recognized in Common Equity Tier 1 Capital.)
Neither the BASEL III rules nor the Call Report Instructions require approval by the institution’s Board of Directors in making the AOCI opt-out election. The BASEL III rules merely state that an institution making the election “must make its AOCI opt-out election in the Call Report…” for the period ending March 31, 2015.
The March 31, 2015, Call Report forms and instructions for Schedule RC-R, Regulatory Capital will illustrate how to make this election on the reporting forms. In addition, all Call Report instructions since March 31, 2014 have included the instructions under Part I.B. of the Instructions for Schedule RC-R. (Part I.A will be deleted in the March 31, 2015 Call Report, with Part I.B renamed Part I.) Pursuant to these Call Report instructions, “An institution that makes an AOCI opt-out election must enter “1” for “Yes” in item 3.a. [of Schedule RC-R, Part I].” Institutions electing not to opt-out of including AOCI in their Common Equity Tier 1 Capital will enter “0” for “No” in item 3.a.
For de novo institutions formed after March 31, 2015 (which presumably will some day exist), the AOCI opt-out election will be made in their first Call Report.
Accordingly, no formal action is required of the Board of Directors by the BASEL III rules or Call Report Instructions. However, given the irrevocable nature of the election and the potential for it to have a material impact on the future capital levels of the institution, we believe it is appropriate for the Board of Directors to be fully informed of the institution’s intentions with regard to the AOCI opt-out election, with the ability to reverse management’s recommendation if so desired by the Board.
The Georgia Department of Banking and Finance has taken a similar position in its January 2015 Bulletin:
The board of directors of all state-chartered, non-advanced approaches institutions should consider carefully all implications of this election in both the long and short terms, as well as in different economic environments. The Board of Directors should fully document discussions of the decision made in its Board meeting minutes. This election is irrevocable and the Department of Banking and Finance (“Department”) encourages the board of directors to fully understand the implications of this election well before the filing of the first quarter 2015 Call Report.
Even if the AOCI opt-out election is made, remember that regulatory examiners are likely to continue to consider the amount of unrealized losses in the investment portfolio (and exposure to the possibility of unrealized losses) when qualitatively assessing capital adequacy and liquidity.