Basel III and Standardized
Approach NPRs
Thomas Farin
President
Farin & Associates, Inc
[email protected]
© 2012 FARIN & Associates Inc.
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Basel 3 Proposed Capital Regs
• Capital Minimums &
Capital Definitions Contained in: Regulatory
Capital Rules: Regulatory
Capital, Implementation of
Basel III (Basel III NPR)
– Issued for 90 day comment
– 6/7/2012
– Effective1/1/2013 with
phase-ins through 1/1/2019
– 250 pages
• Implementation deferred –
effective date will not be
1/1/2013
• Risk Weight Changes Contained in the
(Standardized Approach
NPR)
– released June 7, 2012
– Takes effect Jan 1, 2015
– 250 pages
• (Advanced Approach
NPR)
– Released June 7, 2012
– Applies to most banks over
$50 billion
– Not dealt with in this
presentation
© 2012 FARIN & Associates Inc.
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Capital Definitions
•
•
•
•
•
Common Equity Capital (1 new capital standard)
+ Other Tier 1 Capital
= Total Tier 1 Capital (2 existing capital standards)
+ Tier 2 Capital
= Total Risk Based Capital (1 existing capital
standard)
• Note: Tangible Equity to Total Assets is transition
point from the Severely Undercapitalized to
Critically Undercapitalized designation.
© 2012 FARIN & Associates Inc.
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Capital Definitions
Common Equity Capital Equals
• Tier 1 Capital Instruments (subject to qualifications)
• + Surplus
• - Treasury Stock
• + Retained Earnings
• + Accumulated Other Comprehensive Income (AOCI)
• + Common Equity Tier 1 Minority Interest (subject to qualifications)
• - Regulatory Adjustments & Deductions
– Unrecognized gains and losses on AFS securities (above)
– Goodwill and other intangibles
– Some deferred tax assets (DTAs)
Note: Changes to what qualifies can be subject to transition adjustments
Basel III - p120-131
© 2012 FARIN & Associates Inc.
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Capital Definitions
Additional Tier 1 Capital Equals
• Non-cumulative perpetual preferred stock (subject to
limitations)
– Trust Preferred Stock is excluded from Tier 1
– Excludes instruments classified as liabilities under GAAP
• + Instruments issued under the Small Business
Stabilization Act and the Emergency Economic
Stabilization Act (TARP) that previously qualified as Tier 1
• + Common equity minority interest not included in
Common Equity Capital (subject to limits)
• +/- Regulatory Adjustments
Basel III - p120-131
• Note that TRUPS are phased out of Tier 1
Note: Changes to what qualifies may be subject to transition adjustments
© 2012 FARIN & Associates Inc.
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Capital Definitions
Tier 2 Capital Equals
• Additional Capital Instruments (subject to qualifications)
– Trust Preferred Stock meeting certain criteria could be included
• + Some Term Subordinated Debt
• + Some Limited Life Preferred Stock
• + Instruments issued under the Small Business
Stabilization Act and the Emergency Economic
Stabilization Act (TARP) that previously qualified as Tier 2
• + A portion of ALLL capped at 1.25% of Risk Weighted
Assets
Note: Regulatory adjustments may be subject to transition
adjustments
Basel III - p120-131
© 2012 FARIN & Associates Inc.
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Table 6 – Proposed Requirements
Definition
changes
Risk Weight
changes
Increased or
new
Basel III - p132-136
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Non-Qualifying Capital Phase-Out
2022
Note: This applies to Trust Preferred Stock. Note, shops over $15 B
have it go away quickly. Under $15 billion more slowly (10% per year)
Under $500 million Small Bank HC may not have a phase-out at all.
© 2012 FARIN & Associates Inc.
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Estimated Impact of Standardized Approach
Example
Before
After
AfterAdjusted
Risk-Based Capital
$10
$10
$12
Risk-Based Assets
$100
$120
$120
10.00%
8.33%
10.00%
Risk Based Cap/Assets
Note: impact on your shop may be more or less based on your balance
sheet composition and financial condition.
© 2012 FARIN & Associates Inc.
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Risk Weighted Items – 0%
The following exposures would receive a zero percent risk weight under
the proposal:
• Cash;
• Gold bullion;
• Direct and unconditional claims on the U.S. government, its central
bank, or a U.S. government agency;
• Exposures unconditionally guaranteed by the U.S. government, its
central bank, or a U.S. government agency;
• Claims on certain supranational entities (such as the International
Monetary Fund) and certain multilateral development banking
organizations
• Claims on and exposures unconditionally guaranteed by sovereign
entities that meet certain criteria.
• Note that claims on banks and credit unions fully insured by FDIC or
NCUA are 0% Risk Weight.
No major changes here.
© 2012 FARIN & Associates Inc.
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Risk Weighted Items – 20%
The following exposures would receive a twenty percent risk weight
under the proposal:
• Cash items in the process of collection;
• Exposures conditionally guaranteed by the U.S. government, its
central bank, or a U.S. government agency;
• Claims on government sponsored entities (GSEs);
• Claims on U.S. depository institutions and NCUA-insured credit
unions;
• General obligation claims on, and claims guaranteed by the full faith
and credit of state and local governments (and any other public sector
entity, as defined in the proposal) in the United States;
• Claims on and exposures guaranteed by foreign banks and public
sector entities if the sovereign of incorporation of the foreign bank or
public sector entity meets certain criteria.
No major changes
© 2012 FARIN & Associates Inc.
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Risk Weighted Items – 50%
The following exposures would receive a fifty percent risk weight under
the proposal:
• “Statutory” multifamily mortgage loans meeting certain criteria;
• Presold residential construction loans meeting certain criteria;
consistent with the general risk-based capital rules and requirements
of the statute, the proposal would assign a 100 percent risk weight to
pre-sold construction loans where the contract is cancelled.
• Revenue bonds issued by state and local governments in the United
States.
• Claims on and exposures guaranteed by sovereign entities, foreign
banks, and foreign public sector entities that meet certain criteria (as
described below).
Mortgages broken out.
© 2012 FARIN & Associates Inc.
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Mortgage Risk Weights
The proposed definition of category 1 residential mortgage exposures would generally include
traditional, first-lien, prudently underwritten mortgage loans. The proposed definition of
category 2 residential mortgage exposures would generally include junior-liens and
non-traditional mortgage products.
© 2012 FARIN & Associates Inc.
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Category 2 Criteria?
• > 30 Years
• Deferred principal or
negative amortization
• Balloon ???
• Not well underwritten
• ARM Caps greater than 2/6
• Non-verified income
• 90 days or more past due
• 2nd or later position lien
where institution does not
have all the earlier positions
• One or more positions fail to
meet Category 1 criteria
Standardized Approach – 29-31
•
•
•
The denominator of the LTV
ratio, that is, the value of the
property, would be equal to the
lesser of the actual acquisition
cost for the property (for a
purchase transaction) or the
estimate of a property’s value at
the origination of the loan or at
the time of restructuring or
modification. The estimate of
value would be based on an
appraisal or evaluation of the
property in conformance with
the agencies’ appraisal
regulations …
Numerator includes undrawn
portions of lines.
PMI not considered in
calculating LTV
© 2012 FARIN & Associates Inc.
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Risk Weighted Items – 150%
The proposal would assign a 150 percent risk weight to loans and other
exposures that are 90 days or more past due. This applies to all
exposure categories except for the following:
• 1-4 family residential exposures (1-4 family loans over 90 days past
due and are in Category 2 and would be risk weighted as described
in Section D.)
• A sovereign exposure where the sovereign has experienced a
sovereign default.
• High Risk Development Loans (Commercial ADC and A&D)
New category.
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Equity Exposures
Was mostly 100% except for GSEs
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Equity Exposures
Was mostly 100% except for GSEs
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Risk Weighted Items – 100%
The following exposures would receive a 100 percent risk weight under the
proposal:
• The proposal would assign a 100 percent risk weight to all corporate
exposures. The definition of a corporate exposure would exclude exposures
that are specifically covered elsewhere in the proposal, such as HVCRE, presold residential construction loans, and statutory multifamily mortgages.
• Under the proposed rule, consumer loans and credit cards would continue to
receive a 100 percent risk weight. The proposal does not specifically list
these assets, but they fall into the “other assets” category that would receive
a 100 percent risk weight.
• Where the proposal does not assign a specific risk weight to an asset or
exposure type, the applicable risk weight would be 100 percent. For example,
premises, fixed assets, and other real estate owned receive a risk weight of
100 percent.
• Note: Claims on qualifying securities firms were 20% risk weight and are now
100%.
Similar to past except for specific breakouts above
© 2012 FARIN & Associates Inc.
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Off Balance Sheet Conversion Factors
• Conversion Factor times Risk Weight = Capital
Requirement
– Zero percent CCF. A banking organization would apply
a zero percent CCF to the unused portion of
commitments that are unconditionally cancelable by
the banking organization.
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Off Balance Sheet Conversion Factors
• Conversion Factor times Risk Weight = Capital
Requirement
– 20 percent CCF. A banking organization would apply a
20 percent CCF to:
• Commitments with an original maturity of one year or less that
are not unconditionally cancelable by the banking
organization.
• Self-liquidating, trade-related contingent items that arise from
the movement of goods, with an original maturity of one year
or less.
© 2012 FARIN & Associates Inc.
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Off Balance Sheet Conversion Factors
– 50 percent CCF. A banking organization would apply a
50 percent CCF to:
• Commitments with an original maturity of more than one year
that are not unconditionally cancelable by the banking
organization.
• Transaction-related contingent items, including performance
bonds, bid bonds, warranties, and performance standby letters
of credit.
Note: Conversion factors seem similar but risk weights
|may have changed.
© 2012 FARIN & Associates Inc.
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Off Balance Sheet Conversion Factors
– 100 percent CCF. A banking organization would apply a 100
percent CCF to the following off-balance-sheet items and other
similar transactions:
• Guarantees;
• Repurchase agreements (the off-balance sheet component of which equals
the sum of the current market values of all positions the banking organization
has sold subject to repurchase);
• Off-balance sheet securities lending transactions (the off-balance sheet
component of which equals the sum of the current market values of all
positions the banking organization has lent under the transaction);
• Off-balance sheet securities borrowing transactions (the off-balance sheet
component of which equals the sum of the current market values of all noncash positions the banking organization has posted as collateral under the
transaction);
• Financial standby letters of credit; and
• Forward agreements.
© 2012 FARIN & Associates Inc.
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ALLL Not counted as Capital
ALLL of up to 1.25% of Risk Assets can be counted as Tier 2 Capital.
Excess ALLL over 1.25% can be used to reduce Risk Assets.
© 2012 FARIN & Associates Inc.
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Case Study Institution – Madison Bank
• Capital
• Assets - $500 mm
– Common Equity - $17.53 mm
–
–
–
–
• Unrecog. G/L - $0.71 mm
(subject to phase-out)
– Additional Tier 1 - $7.50 mm
• TRUPS
– Tier 2 - $4.37 mm
• ALLL subject to 1.25% Limit
•
•
•
•
•
•
Cat 1
• Assumptions
–
–
–
–
–
ROA – 0.1%
Dividends/Inc – 30%
Asset Growth – 1.2%
No Capital Injections
Constant B/S Mix
0% - $33.3 mm (0%)
20% - $107.7 mm (20%)
50% - $12.6 mm (50)%
Mortgages (50% & 100%)
Cat 2
–
–
–
–
35% - $0 mm
50% - $54.9 mm
75% - $21.4mm
100% - $8.6 mm
150% - $18.9 mm
200% - $0.0 mm
150% - $13.9 mm (100%)
100% - $234.6 mm (100%)
300% - 3.0 mm (100%)
Conversion Factors
• 20/100% - $7 mm
• 100/100% - $3.0 mm
© 2012 FARIN & Associates Inc.
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Tier 1 Leverage Ratio
Issues
1. Asset growth exceeds capital growth
2. Phase-out of TRUPS
Basel III - p132-136
Requirements don’t change although definition of capital does
© 2012 FARIN & Associates Inc.
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Common Equity Risk Based
Issues:
1. Asset Growth > Capital
Growth
2. New Risk Weights 1/1/15
New requirement being phased in -Note: Proposed regs do not specify a phase in for
undercapitalized and well capitalized. We assumed spreads will
remain constant through the phase-in period.
Capital Conservation
Buffer Phased In
Basel III - p132-136
© 2012 FARIN & Associates Inc.
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Tier 1 Risk Based
Issues:
1. Asset Growth >
Capital Growth
2. TRUPS Phase Out
3. Risk Weights 1/1/15
Basel III - p132-136
Requirement Increased (was 4%/6%)
Buffer Phased In
© 2012 FARIN & Associates Inc.
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Total Risk Based
Issues
1. Asset Growth >
Capital Growth
2. TRUPS Phase Out
3. Risk Weights 1/1/15
4. Little in Tier 2 (ALLL)
Basel III - p132-136
Requirement doesn’t change but risk assets and capital definitions do
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Tangible Equity / Assets
Basel III - p132-136
Only relevant to institutions flirting with Severely/Critically Undercapitalized
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These are Minimums
How will you do this?
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Setting Capital Goals
1. Start with Regulatory Minimums
2. Assess your combined risk
– Credit Risk
– Interest rate risk
– Liquidity risk
How?
1. Stress Test
2. Short Form
3. Add risk buffer from Step 2 to well capitalized
requirement
Assume ABC determines a minimum 2% risk buffer
is appropriate. You will see a capital goal range
on the previous four capital slides.
© 2012 FARIN & Associates Inc.
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OCC Guidance on
Community Bank Stress Testing
•
•
•
•
Issued 10/18/2012
Lays Out Supervisory Expectations
Primarily focused on Credit Stress Testing
Generally Stress Tests Should
– Lay Out Plausible ‘What If’ Questions
– Assess Impact of What-If
– Incorporate Results into Institution Risk Management
Process
• If Major Problems are Uncovered at the Basic
Level, Additional Detailed Analysis May be
Necessary
© 2012 FARIN & Associates Inc.
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Goal Example – Tier 1 Leverage
Example Capital
Goal
+ 2%
Established
Through
Stress Testing
Capital Goal – Answers the Question, “How Much Capital Cushion
Do I Need to Remain Well Capitalized After a Stress Test?”
© 2012 FARIN & Associates Inc.
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Capital Planning Objectives (OCC)
• Capital Plan to Assess Capital Adequacy in Relation to
Overall Risks
• Plan for Maintaining Adequate Capital Levels
• If Analysis Shows Institution Falling Below Regulatory
Minimums, Board and Management Should Take Some
Combination of the Following Actions:
–
–
–
–
–
–
–
Increase Monitoring of Market Information
Adjusting Strategic and Capital Plans
Changing Risk Appetite and Tolerance Levels
Limiting or Stopping Loan Growth and Adjust Mix
Adjusting Underwriting Standards
Raising More Capital
Selling or Hedging Loans
© 2012 FARIN & Associates Inc.
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Credit Risk Stress Tests
Types of Stress Tests
• Transaction Stress Testing – Bottom up analysis
beginning at loan level
• Portfolio Stress Testing
– Bottom Up – Transaction Stress Tests
– Top Down – Applying Loss Rates to Pools of Loans
• Enterprise Level Testing – Incorporates Multiple Kinds of
Risk (Integrated) – Assumptions Derived from Same
Economic Scenarios
• Reverse Stress Testing – Assumes Specific Adverse
Outcome (Capital Failure) then Deduces Kinds of Events
Leading to This Outcome
© 2012 FARIN & Associates Inc.
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Where are we Headed
• Enterprise Stress Tests
– Interest Rate Risk
– Credit Risk
– Liquidity Risk
• Effect on Income
• Effect on Capital
• Capital Should be Sufficient to Absorb Effect of
Stress Test While Remaining Well Capitalized
© 2012 FARIN & Associates Inc.
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