News & Events

New Capital Rules for Community Banks

While small banks avoided some of the dreaded brunt of Basel III, this summer’s capital changes require all banks to reconsider their capital positions and may drive some banks to raise capital. Fortunately, the final rules exempt community banks from many of the more onerous proposals. However, many of the changes do apply to community banks, and all banks must take stock of their capital positions carefully to determine whether proactive steps are needed before the rules take effect.

Here are some important highlights community bankers should know about the final rules:

Capital Treatment of Residential Mortgages. If impossibly complicated risk weighting for residential mortgage loans caused sleepless nights, you can rest easy. The initial Basel III proposals threatened a complex calculation of capital risk weighting for one to four family residential mortgage loans that would have required a loan-by-loan weighting based upon a complicated matrix of loan terms, loan to value ratios, and payment status. Perhaps with a nod to community bankers who pointed out that these complex rules would make less credit available to a large number of borrow ers, the final rules abandoned the proposal altogether. The resulting good news for community banks is that the capital treatment of mortgage loans will remain unchanged: 50% weighting for prudently underwritten first lien mortgage loans that are not past due, on nonaccrual, or restructured and 100% weighting for other mortgage loans.

Phase Out of Trust Preferred Securities and Certain Preferred Stock. For banks with less than $15 billion in consolidated assets as of December 31, 2009, only trust preferred securities and cumulative perpetual preferred stock issued prior to May 19, 2010 can continue to be counted as Tier 1 capital. To be clear, “noncumulative” perpetual preferred stock remains a part of Tier 1 capital. The difference in “cumulative” and “noncumulative” is the treatment of missed dividend payments—missed dividend payments on cumulative preferred stock remain ongoing payment obligations of the company until paid (in other words, missed dividends “cumulate” until paid) while missed dividends on noncumulative stock need not be paid later.

New Common Equity Tier 1 Ratio. Codifying the regulatory view that common equity is the best form of capital, the final rules add a new capital ratio to measure an institution’s common equity capital. Beginning in 2015, banks must maintain a 4.5% common equity Tier 1 ratio. In practice, the new rule may not challenge many community banks since smaller institutions tend to have higher levels of common equity capital than larger, more complex institutions that may rely more heavily on other capital instruments. Many community banks may need to move quickly to consider a sale of common stock before 2015 to raise their Common Equity Tier 1 Ratio to at least 4.5% or higher for banks seeking well capitalized status or banks planning to pay dividends (see discussion below regarding the new capital conservation buffer).

Revised Minimum Capital Requirements. Beginning in January 2015, minimum capital requirements will be:

  • Common Equity Tier 1 Capital: 4.5% (new requirement)
  • Tier 1 Capital / Risk Weighted Assets: 6% (raised from current 4%)
  • Total Capital / Risk Weighted Assets: 8%
  • Leverage Ratio: 4%

Prompt Corrective Action Levels. Beginning in 2015, the following prompt corrective action levels will apply:

Well CapitalizedAdequately CapitalizedUndercapitalizedSignificantly Undercapitalized
Common Equity Tier 1 Capital Ratio≥ 6.5%≥ 4.5%< 4.5%< 3%
Tier 1 Capital Ratio≥ 8%≥ 6%< 6%< 4%
Total Capital Ratio≥ 10%≥ 8%< 8%< 6%
Leverage Ratio≥ 5%≥ 4%< 4%< 3%

Capital Conservation Buffer. A capital buffer will be required to ensure that sufficient capital is maintained when making certain payments such as dividend payments and some discretionary bonus payments to executives. The buffer uses a sliding scale, so a bank holding a larger capital buffer will be afforded greater leeway to make these payments. A bank with a capital buffer of less than 0.625% of its eligible retained income would be prohibited from making these payments altogether. Since the buffer is capital above the required minimum capital levels, the capital conservation buffer effectively raises the minimum capital levels for banks intending to pay dividends or executive bonuses. The capital conservation buffer will be implemented incrementally beginning in 2016.

Banking Notes is a quarterly newsletter created by Butler Snow ’s banking team to address legal issues of interest to bank management and directors. Banking Notes regularly contains articles from Beth W. Sims and Adam G. Smith in Nashville, TN and Jefferson K. B. Stancill in Ridgeland, MS. Banking Notes also frequently includes relevant and timely contributions from attorneys in a variety of other practice areas at Butler Snow. For more information about any of these topics, do not hesitate to contact us.