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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.