The public comment period for the banking agencies’ capital simplification rules for qualifying community banking organizations (i.e. the Community Bank Leverage Ratio proposal) are due on Tuesday, April 9th.
As previously discussed, the regulators have proposed a new, alternative, simplified capital regime for qualifying institutions that will deem an institution to be well-capitalized so long as it maintains a leverage ratio of at least 9% and adequately capitalized so long as it maintains a leverage ratio of at least 7.5%. While initially proposed last November, publication in the Federal Register was delayed until February of this year. As a result the comment period for the rule ends on Tuesday, April 9, 2019. Comments can be submitted online through Regulations.gov.
Through the publication of this blog post, the primary comments online appear to be the appropriate threshold for the new Community Bank Leverage Ratio. As background, EGRRCPA, the statutory basis for the reforms, obligates the regulators to apply a threshold of between 8% and 10%, and the regulators proposed 9%. Most of the submitted comments, including several from community bankers, comments from the Kansas Bankers Association and the Independent Bankers Association of Texas argue for a lower 8% ratio. Conversely, the Mercatus Center has submitted a comment supporting a 10% ratio.
Under the Economic Growth, Regulatory Reform and Consumer Protection Act, depository institutions and their holding companies with less than $10 billion in assets are excluded from the prohibitions of the Volcker Rule. Accordingly, institutions under $10 billion may, so long as consistent with general safety and soundness concerns, engage once again in proprietary trading and in making investments in covered funds.
Neither EGRRCPA nor the proposed rule, however, addresses the impact on an institution when it goes over $10 billion in assets, either as a result of organic growth or via merger. The proposed rule does not even apply the tests on a quarter-end or other reporting period basis, much less an average balance or consecutive quarter requirement. The proposing release notes that they believe that insured depository institutions “regularly monitor their total consolidated assets” for other purposes, and therefore do not believe this ongoing test requirement would impose any new burden.
The Economic Growth, Regulatory Relief and Consumer Protection Act (EGRRCPA) provided significant regulatory relief for community banks, including broad relief from the Volcker Rule’s prohibition on proprietary trading and investments in covered funds. As previously discussed, Section 203 of EGRRCPA provided an exemption from the Volcker Rule for institutions that are less than $10 billion and whose total trading assets and liabilities are not more than 5% of total consolidated assets. The exemption provides complete relief from the Volcker Rule by exempting such depository institutions from the definition of “banking entity” for purposes of the Volcker Rule.
On December 21, 2018, the financial regulatory agencies invited public comments on a proposal to implement the EGRRCPA changes to the Volcker Rule. The proposed rule provides that an insured depository institution is exempt from the Volcker Rule if “it has, and every company that controls it has, total consolidated assets of $10 billion or less and total trading assets and trading liabilities, on a consolidated basis, that are 5% or less of total consolidated assets.” While the proposed rule is not yet effective, the Federal Reserve has previously confirmed that it would not enforce the Volcker Rule in a manner inconsistent with EGRRCPA, so the proposed rule is effectively already in place.
Based on September 30, 2018 call report data, this change to the Volcker Rule exempted approximately 97.5% of the 5,486 U.S. depository institutions. (The actual number is probably slightly less, as some of those exempted depository institutions are affiliated with larger and/or foreign banks, each of which would remain subject to the Volcker Rule.) Of note, the $10 billion asset threshold is by far the most relevant determinant of the eligible relief. Based on that call report data (which necessarily excludes any trading assets and liabilities held by a parent company), only 0.15% of depository institutions had trading assets equal to at least 5% of their total assets (and only 0.16% of the institutions had trading assets equal to 3% or more of their total assets).
While few community banks ever engaged in proprietary trading before the Volcker Rule, EGRRCPA still provides meaningful relief from the compliance obligations of the Volcker Rule, the risk of inadvertently being deemed to engage in proprietary trading, or the prohibition from investing in covered funds (or the need to ensure that vehicles that were invested in qualified for an exemption from the covered fund definition).
On December 27th, Jonathan and I returned to the studio to record the latest podcast for The Bank Account. We haven’t discussed New Year’s Resolutions, but we’ll try to return to a little more normalcy in 2019!
For those that have missing our voices, (a) please seek help… that’s not normal and (b) we were also recently guests on the ABA Banking Journal Podcast. In a lively conversation with Evan Sparks and Shaun Kern, Jonathan and I discussed our 2019 M&A Outlook for the ABA Banking Journal. For those of you who have missed that podcast (or article), I encourage you to listen/read before listening to this podcast, as we follow-up on some of these themes.
Our first substantive conversation on this podcast is a look at some of the transactions announced in the Metro Atlanta market in 2018. With State Bank’s merger with Cadence, Fidelity Bank with Ameris Bank, and National Commerce with CenterState, the Atlanta banking market, and particularly the M&A market, will look radically different in 2019 and beyond.
Following the M&A discussion, our attention turned to the newly proposed Community Bank Leverage Ratio. While it is solely a proposed rule and, if adopted in its current structure, will be an entirely optional framework for banks under $10 billion in assets, it also provides the potential for significant regulatory relief for those institutions that can take advantage of the capital (particularly risk-based) relief.
On November 21, 2018, the Federal Reserve, Office of Comptroller of the Currency and the FDIC jointly published a notice of proposed rulemaking (the “NPR”) to provide an alternative capital system for qualifying banking organizations. Specifically, the regulators have proposed a new, alternative, simplified capital regime for qualifying institutions that will deem an institution to be well-capitalized so long as it maintains a leverage ratio of at least 9% and adequately capitalized so long as it maintains a leverage ratio of at least 7.5%.
The NPR seeks to implement the community bank leverage ratio (CBLR) mandated by Section 201 of the Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”). EGRRCPA requires the regulatory agencies to develop a CBLR of not less than 8 percent and not more than 10 percent for qualifying community banking organizations, and provides that organizations that meet such CBLR will deemed well capitalized for all purposes. EGRRCPA further provides that a qualifying community banking organization to be a depository institution or depository institution holding company with total consolidated assets of less than $10 billion.
Summary of the NPR
The NPR establishes five criteria for an depository institution or holding company to be deemed a Qualifying Community Banking Organization:
Total consolidated assets of less than $10 billion;
Total off-balance sheet exposures of 25% or less of total consolidated assets;
Total trading assets and trading liabilities of 5% or less of total consolidated assets;
MSAs of 25% or less of CBLR tangible equity; and
Temporary difference DTAs of 25% or less of CBLR tangible equity.
Under the NPR, the numerator of the CBLR would be CBLR tangible equity. CBLR tangible equity would be equal to total equity capital, determined in accordance with Call Report or Form Y-9C instructions, prior to including any minority interests, less (i) accumulated other comprehensive income (AOCI), (ii) all intangible assets (other than MSAs) including goodwill and core deposit intangibles, and (iii) DTA’s arising from net operating loss and tax credit carryforwards.
The CBLR denominator would be average total consolidated assets, calculated in accordance with Call Report or Form Y-9C instructions, less the items deducted from the CBLR numerator, except AOCI. The NPR notes that the calculation is similar to the one used in determining the denominator of the tier 1 leverage ratio.
Under the NPR, a Qualifying Community Banking Organization may elect to use the CBLR framework at any time, so long as it has a CBLR greater than 9% at the time of the election. Under the CBLR framework, the Qualifying Community Banking Organization will be considered well capitalized so long as it has a CBLR greater than 9%. A qualifying depository institution that previously elected to use the CBLR framework but has fallen below 9% will not be required to convert back to the regular capital system. Instead, the following CBLR leves will serve as proxies for the PCA categories:
Adequately Capitalized – CBLR of 7.5% or greater;
Undercapitalized – CBLR of less than 7.5%; and
Significantly Undercapitalized – CBLR of less than 6%.
The framework for Critically Undercapitalized would remain unchanged at a ratio of tangible equity to total assets of 2% or below. Any institution that would be deemed Significantly Undercapitalized under the CBLR framework would be required to promptly provide its appropriate regulators sufficient information to calculate the PCA tangible equity ratio.
On substantive issues, we primarily focused on reforms enacted under The Economic Growth, Regulatory Relief, and Consumer Protection Act, or EGRRCPA, but also touched on the modernization of the Georgia banking code. Specific topics discussed include:
the expansion of the Small Bank Holding Company Policy Statement;
the relaxation of the reciprocal brokered deposit rules;
Volcker Rule relief;
the upcoming regulatory off-ramp (or at least rest stop, if not fully an off-ramp); and
the increased threshold for the 18-month examination cycle and short-form call reports.
As of the end of August 2018, two key provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (aka the Crapo bill, S.2155, or increasingly, EGRRCPA) have become effective: the increase in the small bank holding company policy statement threshold and the increase in the expanded examination cycle threshold. Before looking at those provisions, I have to acknowledge the fabulous Wall Street Journal story by Ryan Tracy, “Can You Say EGRRCPA? Tongue-Twister Banking Law Confuses Washington.” Personally, I’m now leaning towards “egg-rah-sip-uh.”
On July 6, 2018, the federal banking agencies released an Interagency statement regarding the impact of the Economic Growth, Regulatory Relief, and Consumer Protection Act that provided guidance as to which provisions were immediately effective versus which provisions would require further regulatory action. Included in this guidance was confirmation that the banking regulators would immediately implement EGRRCPA’s changes to the Volcker Rule, freeing most institutions with total assets of less than $10 billion from the constraints of the Volcker Rule. The regulators noted that they “will not enforce the final rule implementing section 13 of the BHC Act in a manner inconsistent with the amendments made by EGRRCPA to section 13 of the BHC Act.”
Unfortunately, two of the more significant areas of regulatory relief for community banks, the respective increases in thresholds for the small bank holding company policy statement and the expanded examination cycle were not granted such immediate effectiveness. While EGRRCPA required the Federal Reserve to act on the expansion of the policy statement within 180 days, anyone familiar with the deadlines set forth in the Dodd-Frank Act for regulatory action would not be holding their breath.
Small Bank Holding Company Policy Statement Expansion. On August 30, 2018, the Federal Reserve published an interim final rule implementing the revisions to the small bank holding company policy statement. The Federal Reserve’s small bank holding company policy statement generally exempts such institutions from the requirement to maintain consolidated regulatory capital ratios; instead, regulatory capital ratios only apply at the subsidiary bank level. The small bank holding company policy statement was first implemented in 1980, with a $150 million asset threshold. In 2006, it was increased to $500 million, and in 2015, it was increased to $1 billion. Section 207 of EGRRCPA called for the Federal Reserve to increase the threshold to $3 billion, and the interim final rule implements this change.
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