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Bryan Cave Lawyers Briefing State Banking Associations on Basel III Proposals

In recent weeks, three Bryan Cave lawyers have briefed state banking association members on the impact the Notices of Proposed Rule Making regarding Basel III could have on banks of all sizes. On July 12, Jonathan Hightower presented via webinar to the Georgia Bankers Association. On August 16, Jonathan Hightower and B.T. Atkinson participated in a live seminar on Basel III presented by the South Carolina Bankers Association that also included presentations by Garry Rank of Elliott Davis, LLP and Jim Mabry of Keefe, Bruyette & Woods. The SCBA program also included a segment advising institutions on how to prepare a comment letter on the proposals for submission to their primary federal banking agency. On August 20, Michael Shumaker and B.T. Atkinson presented via webinar to the North Carolina Bankers Association. In all three programs, bankers were strongly encouraged to submit comments on the proposals by the October 22 deadline, citing specific examples of how the proposed rules could negatively impact their bank. Areas noted for potential comment included:

  • phase-out of trust preferred from Tier 1 capital for institutions having less than $15 billion in assets; 
  • appropriateness of the capital conservation buffer for banking organizations that are not systemically significant; 
  • inclusion of unrealized gains and losses on securities in common equity Tier 1 capital; 
  • whether the exclusion for bank holding companies having total assets of $500 million or less should be increased to $1 billion and include savings and loan holding companies; and 
  • the impact of the proposed risk-weighting of first and second lien mortgages on product availability and the anticipated burdens of implementation.

Links to related Financial Institution Letters:

FIL-25-2012:  Regulatory Capital Rules:  Regulatory Capital, implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, and Transition Provisions

FIL-27-2012:  Regulatory Capital Rules:  Standardized Approach for Risk-Weighted Assets; Market Discipline and Disclosure Requirements

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Basel III – Unconditional Guarantees and the New Risk Weights for Past Due Assets

As we continue our review of the proposed Basel III capital and risk-weighting rules, we have identified additional features of the proposed rules that may prove meaningful to community banks. One of the more significant changes provided by the Basel III proposal relates to the higher risk weights given to credit exposures (other than exposures to sovereign debt or residential mortgages) that are more than 90 days past due.

Under the current risk-weighting rules, there is no change in risk-weighting when an asset becomes 90 days past due, with all commercial loans, regardless of whether they are past due or paying as agreed, given a risk weight of 100%. However, under the proposed Basel III rules, the “portion of the [past due] exposure that is not guaranteed or that is unsecured” would receive a risk weight of 150%.

If the new Basel III rules had been in place during the last crisis, many banks could have found themselves in much deeper trouble earlier on in the cycle. With falling collateral prices resulting in more loans becoming unsecured, the increased risk weights assessed on high levels of past due loans would have resulted in lower capital ratios more quickly. However, considering the language of the proposed Basel III rules, would the existence of a borrower’s unconditional guarantee have been enough to avoid assessment of the higher risk weights? Although the letter of the proposed Basel III rules seems to create an exception from the new risk weights for fully guaranteed loans that are past due, recent regulatory guidance seems to undercut this reading.

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Financial Services Update

Financial Services Update

November 22, 2010

Authored by: Matt Jessee

Debate Over Extension of Bush Tax Cuts Continues

On Thursday, House Majority Leader Steny Hoyer (D-MD) and House Speaker Nancy Pelosi (D-CA) told House Democrats at a closed door meeting that the House would vote before the end of the year on extending the Bush tax cuts for only those individuals making less than $250,000. However, even if such a measure were to pass in the House, it is unclear whether the Senate will agree to such a vote. There is still the possibility the bill may not pass the House if Republicans are able to successfully pass a procedural response, known as a “motion to recommit,” that could force a House vote on a full extension of the Bush tax cuts.  According to sources, Pelosi told President Barack Obama that House Democrats remain firmly committed to allowing Bush-era tax cuts to expire for earners making more than $250,000, which complicates the Administration’s efforts to reach a compromise with Senate Republicans.

Preview of Next Year’s Budget Fight

On Thursday, Senate Minority Leader Mitch McConnell (R-KY) announced he would oppose the pending omnibus appropriations bill, thereby forcing Congress to rely on another stopgap “continuing resolution,” or CR, to keep the government funded after December 3. If Republicans are able to block the omnibus spending bill, it would set up an early confrontation with President Obama next year over not just deeper cuts from the President’s 2011 budget but also tens of billions of dollars in rescissions from prior years. The White House is seeking a continuing funding resolution which would cover the next 10 months of the fiscal year until September 30, which would deny House Republicans a chance to defund portions of the healthcare bill early next year.

Fed Orders New Stress Tests

On Wednesday, the Federal Reserve announced plans to scrutinize the nation’s top 19 banks through a second round of “stress tests.” The stress tests will require the bank-holding companies to submit capital plans by early 2011 proving their capability to handle losses under a set of conditions including “adverse” economic conditions and continuing real estate-related problems. In its announcement, the Fed said it plans to perform such reviews regularly on an ongoing basis. The Fed also issued a road map for banks that want to raise dividends or buy back stock saying firms must show they have sufficient capital in place to withstand losses over the next two years and demonstrate an ability to satisfy new, tougher global capital requirements.

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FDIC Takes Dim View on Raising Capital via Minority Interests in Real Estate Subsidiaries

A number of banks have recently been examining the possibility of raising capital through the sale of a minority interest in a subsidiary set up to hold bank owned real estate such as bank headquarters and branches.

Part 325 of the FDIC Rules and Regulations indicates that Tier 1 Capital includes minority interests in equity capital accounts of those subsidiaries that have been consolidated for the purpose of computing regulatory capital, (except that minority interests which fail to provide meaningful capital support are excluded from the definition).   Stock held by minority shareholders in a bank controlled subsidiary whose assets are consolidated with those of the bank are not generally recognized as equity capital under GAAP, but the bank regulatory agencies have in the past counted it as regulatory capital.

We have been informed by the FDIC that the current regulatory view of such transactions is not favorable.   Their position is that subsidiaries typically are not normally formed for the sole intent of raising capital, and that minority interests usually arise when a bank acquires a pre-existing subsidiary.   From a corporate perspective, the FDIC is currently taking the position it will not be allowing banks to transfer assets to a subsidiary for the sole intent of raising temporary capital, particularly if the investors have a preferred claim or return on such assets.   Accordingly, institutions looking to raise capital are unlikely to find any relief by selling interests in the bank’s existing owned real estate.

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Boards and Strategic Planning in a Challenging Environment

Short-Term Planning for Recovery and Survival

(This post was authored by Walt Moeling and Dustin Hall.  A version of this post originally appeared in the August 2009 issue of the ABA’s Community Banker magazine.)

The grim economic prognoses we continue to hear about have an immediate impact in the bank board room. Boards must think about short-term planning for recovery and survival because virtually no bank is wholly immune from the current recession.  Although the problems may have started with residential real estate in the Sunbelt, they have gone much beyond that now, impacting banks throughout the country.

As a director you must plan for both long-term and short-term.  Long-term planning is tremendously important, and we hope to make it to the “long-term,” but short-term planning is critical today.

Short-term planning in this context deals with the reality of today’s marketplace.  The focus is not on earnings or even stock value, two traditional focal points for planning.  Instead, the focus is on capital management, liquidity, and asset quality.

Capital Management

Your short-term capital planning in the face of mounting losses cannot focus on today or yesterday; it must focus on tomorrow.  You must ask: Where are we going?  What will happen if housing prices drop for another two and a half years, as predicted by some?  Can our borrowers sustain a more prolonged recession?  If not, where will our capital be three, six, and nine months from now?  In essence, you must stress test your bank to see how far it can go.

A real problem for directors is assuming that capital today is as readily available as it has been for the past 15 years, or that they can sell the bank if there is a real problem.  Unfortunately, there is no public market, and virtually no private equity, for bank stock.  Those sources are presently closed, shall we say, for repair.  Instead, short-term capital is likely to be found only within the boardroom and from family and friends.

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Reminder Regarding Inclusion of Trust Preferred Securities in Tier 1 Capital

Although the trust preferred securities (“TPS”) market has been quiet (or non-existent) for the past few years, many bank holding companies have issued TPS in the past to take advantage of the hybrid capital treatment afforded to TPS by the Federal Reserve.  In 2005, the Federal Reserve revised its rules permitting the inclusion of a limited amount of TPS in the Tier 1 capital to provide stricter quantitative limits. Under the 2005 rule, which became effective on March 31, 2009, bank holding companies may include TPS in Tier 1 capital in an amount up to 25% of all core capital elements less goodwill and any associated deferred tax liability. Core capital elements include common shareholders’ equity, noncumulative perpetual preferred stock (including preferred stock issued pursuant to the Troubled Asset Relief Program (TARP)), and minority interests directly issued by a consolidated U.S. depository institution or foreign bank subsidiary. Any TPS issued in excess of this limit may be included in Tier 2 capital.

Prior to March 31, 2009, bank holding companies were permitted to calculate the limit for TPS without deducting goodwill and associated deferred tax liability from Tier 1 capital. The regulators are now taking note that some bank holding companies with outstanding TPS have not revised their Tier 1 calculations to comply with the newly-effective rule. If your bank has a holding company with outstanding TPS, be sure that you are limiting the TPS component of Tier 1 capital to 25% of core capital elements less goodwill and any associated deferred tax liability.

In addition, in the current economic environment, many bank holding companies are experiencing deterioration in capital. When the core capital elements of Tier 1 capital decline, the amount of TPS that may be included in Tier 1 capital also declines, thereby further reducing a bank holding company’s leverage ratio. When calculating capital ratios, bank holding companies must remember to re-evaluate the inclusion of TPS in Tier 1 capital as capital declines.

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Using the TLGP Debt Guarantee to Provide Capital

We are having discussions with clients regarding the possibility of issuing FDIC-guaranteed debt under the TLGP’s Debt Guarantee Program at the holding company level and using the proceeds of that debt to increase the capital of the bank subsidiary.  This is particularly attractive for banks that are eligible to report their risk-based capital positions on a bank-only basis.  (The Federal Reserve’s risk-based capital measures are generally applied on a bank-only basis for bank holding companies with consolidated assets of less than $500 million.)

Permissible Use for BHC FDIC-Guaranteed Debt

The FDIC’s Frequently Asked Questions (FAQ) explicitly permits a bank holding company to use the proceeds from a guaranteed debt issuance to purchase additional shares of bank stock.

Need to Apply to FDIC for Approval

In our experience, however, most bank holding companies for community banks had no, or very limited amounts of, senior unsecured debt outstanding as of September 30, 2008.  As a result, the bank holding company will have to file a letter application with the FDIC and, if different, the federal banking regulator for its largest subsidiary bank to establish an FDIC-guaranteed debt limit.  The letter application must describe the details of the request, provide a summary of the applicant’s strategic operating plan, and describe the proposed use of the debt proceeds.

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