Bank Board Letter January 2014 : Page 2

6.5 percent, 8 percent and 10 percent, respectively. The increases should not be an area of significant concern for a great majority of community banks. According to the Federal Reserve, “nine out of 10 financial institutions with less than $10 billion in assets would meet the common equity Tier 1 minimum plus buffer of 7 percent in the final rule.” The FDIC believes that 95 percent of all insured depository institutions would be in compliance with the minimums and buffers if the new rules were effective immediately. The new rules do include material changes to the capital criteria. The implementation of stricter eligibility criteria for regulatory capital will prohibit the inclusion of financial instru-ments such as trust-preferred securities in Tier 1 capital going forward; however, the banking agencies did show some restraint by revising or striking certain overly burdensome and unneces-sary provisions of the previous proposals. For example, one area of particular importance to commu-nity banking organizations is the treatment of TRuPs that are already on the books of community banking organizations. The treatment of TRuPs under the previous proposals would have been extremely detrimental to community banking organiza-tions. Community bankers across the country voiced their con cerns and opposition to the new treatment. In an effort to ease the burden on community banking organizations, the agencies provided exemptions for smaller organizations. Under the new scheme, bank holding companies with less than $15 billion in total consolidated assets as of Dec. 31, 2009, may continue to classify TRuPs that were issued prior to May 19, 2010, as Tier 1 capital. The grandfathered TRuPs may only account for up to 25 percent of the bank holding compa-nies’ Tier 1 capital. This is particularly important for community banking organizations that have limited access to additional capital, and should be seen as a victory for community banks. (EDITOR’S NOTE: This article was written before federal regulators issued the long-awaited Volcker Rule on Dec. 10, 2013, which may require community banks to write down their holdings of collateralized debt obligations backed by trust-preferred securities. Following objections from trade groups, the regulators said they would consider whether it is appropriate and consistent with the provisions of the Dodd-Frank Act not to subject pooled investment vehicles for TRuPS, such as collat-eralized debt obligations backed by TRuPS, to the prohibitions on ownership of covered funds in section 619 of the Dodd-Frank Act, and promised to address the matter by Jan. 15.) The proposals relating to residential mortgage exposures were also noticeably absent from the new rules. Accordingly, treat-ment of one-to-four-family residential mortgage exposures re-mains the same as under the current general risk-based capital rule. This means that prudently underwritten first-lien mort-gage loans that are not past due, reported as non-accrual or restructured will receive a 50 percent risk weight, while all other residential mortgages will default to a 100 percent risk weight. This prevents community banks from having to re-classify much of their mortgage loan portfolios, which could have caused many banks to reduce their regulatory capital levels. Another concern was the requirement that all banking or-ganizations must include available for sale securities in their common equity Tier 1 capital. The conveyance of those con-cerns by community banks caused regulators to rethink the proposals. In the new rules, community banks will not have to adjust capital levels due to the fluctuations in the current market value of the available for sale securities on their bal-ance sheets. This should help those banks avoid unsafe and unnecessary volatility in capital adequacy. Additionally, community banks are given a one-time opportunity to opt out of the filter of accumulated other comprehensive income. The AOCI opt-out election must be made on the institution’s first call report, FR Y-9C, or FR Y-9SP, as applicable, filed after Jan. 1, 2015. In addition to creating the common equity Tier 1 capital minimum, beginning in 2016, banking organizations will be required to hold a capital conservation buffer. The buffer will be the amount of an institutions’ common equity Tier 1 capital above its minimum risk-based capital requirements. This will prevent many institutions from issuing dividend payments or certain discretionary bonus payments to execu-tive officers. The institutions holding a buffer greater than 2.5 percent will not be restricted from issuing capital distributions. On the other hand, institutions that do not meet the 2.5 percent minimum will face ever-increasing limits on distributions as the capital conservation buffer approaches zero. Community banks will not be subject to the capital conservation buf-fer requirements until Jan. 1, 2016; however, once they are fully implemented, the minimum capital requirements plus the capital conservation buffer will exceed the current well-capitalized minimum. Only time will tell whether the new rules will produce more-appropriate capital requirements that in turn lead to a stronger banking system. In the meantime, community banks must do what may be the hardest aspect of complying with the new rules implementing Basel III — take the time to analyze and understand the new rules and commit the resources necessary to ensure they are in compliance with the increased regulations on Jan. 1, 2015. Sanford Brown, a partner with Bracewell & Giuliani, LLP and can be reached at Justin Long, a partner in Bracewell & Giuliani’s financial institutions section, can be reached at Joshua McNulty is an attorney with Bracewell & Giuliani and can be reached at NEXT MONTH: Board Committees

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