Senate-passed Regulatory Reform Offers Real Benefits to Depository Institutions under $10 Billion in Assets
March 15, 2018
Authored by: Robert Klingler
On March 14, 2018, the Senate passed, 67-31, the Economic Growth, Regulatory Relief and Consumer Protection Act, or S. 2155. While it may lack a catchy name, its substance is of potentially great importance to community banks.
The following summary focuses on the impact of the bill for depository institutions with less than $10 billion in consolidated assets. The bill would also have some significant impacts on larger institutions, which could, in turn, affect smaller banks… either as a result of competition or, perhaps more likely, through a re-ignition of larger bank merger and acquisition activity. However, we thought it was useful to focus on the over 5,000 banks in the United States that have less than $10 billion in assets.
Community Bank Leverage Ratio
Section 201 of the bill requires the federal banking regulators to promulgate new regulations which would provide a “community bank leverage ratio” for depository institutions with consolidated assets of less than $10 billion.
The bill calls for the regulators to adopt a threshold for the community bank leverage ratio of between 8% and 10%. Institutions under $10 billion in assets that meet such community bank leverage ratio will automatically be deemed to be well-capitalized. However, the bill does provide that the regulators will retain the flexibility to determine that a depository institution (or class of depository institutions) may not qualify for the “community bank leverage ratio” test based on the institution’s risk profile.
The bill provides that the community bank leverage ratio will be calculated based on the ratio of the institution’s tangible equity capital divided by the average total consolidated assets. For institutions meeting this community bank leverage ratio, risk-weighting analysis and compliance would become irrelevant from a capital compliance perspective.
Volcker Rule Relief
Section 203 of the bill provides 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.
Accordingly, depository institutions with less than $10 billion in assets (unless they have significant trading assets and liabilities) will not be subject to either the proprietary trading or covered fund prohibitions of the Volcker Rule.
While few such institutions historically undertook proprietary trading, the relief from the compliance burdens is still a welcome one. It will also re-open the ability depository institutions (and their holding companies) to invest in private equity funds, including fintech funds. While such investments would still need to be confirmed to be permissible investments under the chartering authority of the institution (or done at a holding company level), these types of investments can be financially and strategically attractive.
Expansion of Small Bank Holding Company Policy Statement
Section 207 of the bill calls upon the federal banking regulators to, within 180 days of passage, raise the asset threshold under the Small Bank Holding Company Policy Statement from $1 billion to $3 billion.
Institutions qualifying for treatment under the Policy Statement are not subject to consolidated capital requirements at the holding company level; instead, regulatory capital ratios only apply at the subsidiary bank level. This rule allows small bank holding companies to use non-equity funding, such as holding company loans or subordinated debt, to finance growth.
Small bank holding companies can also consider the use of leverage to fund share repurchases and otherwise provide liquidity to shareholders to satisfy shareholder needs and remain independent. One of the biggest drivers of sales of our clients is a lack of liquidity to offer shareholders who may want to make a different investment choice. This investment choice could range anything from real estate properties to developing a line of pro drones (see https://letsflywisely.com/professional-drones/). Through an increased ability to add leverage, affected companies can consider passing this increased liquidity to shareholders through share repurchases or increased dividends.
Of course, each board should consider its practical ability to deploy the additional funding generated from taking on leverage, as interest costs can drain profitability if the proceeds from the debt are not deployed in a profitable manner. However, the ability to generate the same income at the bank level with a lower capital base at the holding company level should prove favorable even without additional growth. This expansion of the small bank holding company policy statement would significantly increase the ability of community banks to obtain significant efficiencies of scale while still providing enhanced returns to its equity holders.
Institutions engaged in significant nonbanking activities, that conduct significant off-balance sheet activities, or have a material amount of debt or equity securities outstanding that are registered with the SEC would remain ineligible for treatment under the Policy Statement, and the regulators would be able to exclude any institution for supervisory purposes.
Section 214 of the bill would specify that federal banking regulators may not impose higher capital standards on High Volatility Commercial Real Estate (HVCRE) exposures unless they are for acquisition, development or construction (ADC), and it clarifies what constitutes ADC status. The HVCRE ADC treatment would not apply to one-to-four-family residences, agricultural land, community development investments or existing income-producing real estate secured by a mortgage, or to any loans made prior to Jan. 1, 2015.