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Speak Now, or Forever…

By: Kevin Doyle

It has been almost four months since the Federal Reserve Board proposed regulatory capital reforms and invited comment. At this point, all depository institutions are generally aware of the onerous provisions of the Basel III capital reforms and related changes required by the Dodd-Frank Act.

In addition to increasing the required risk-weighted capital ratios for depository institutions of all sizes, the proposal would narrow the definition of capital and increase the risk weightings of most assets. Suffice it to say, the cumulative impact of changes to all three of these variables would be cumbersome at best, for all financial institutions, and potentially, life-threatening for some.

As proposed, all measures of capital would include the gains and losses from securities designated “available for sale” under FAS 115. Any fluctuation in the unrealized value of the AFS securities would immediately impact regulatory capital.

Collectively, financial institutions now hold more than 90 percent of their investment securities in the AFS account. Re-classifying a significant portion of the investment portfolio as held to maturity would reduce the volatility of the capital position, but at what price? Transitioning securities to the HTM account would reduce overall liquidity (another regulatory concern) and limit flexibility in managing the portfolio.

But the Basel III proposal, together with the Standardized Approach, is far more complicated than simply managing the AFS/HTM trade-off of capital preservation and liquidity maintenance.

Which of the many issues presented are potentially most threatening to your institution?

Unrealized gains/losses now included in Tier 1 capital: Banks with a relatively large AFS bond portfolio, particularly if it is longer in duration, will be more vulnerable to capital fluctuation. The potential loss on securities, in a +300 basis points rate scenario, should be considered and compared to Tier 1 capital projections.

Trust preferred securities excluded from Tier 1 capital: Trust preferred securities will no longer qualify as Tier 1 capital for holding companies over $500 million. Although there is a 10-year phaseout, some institutions rely on TPS for a significant portion of their capital bases, and some have TARP or SBLF money to eventually replace. Alternative sources of capital should be considered, as well as the cost of new capital.

New risk weightings for 1-4 residential loans: These loans will now be divided between category 1 and category 2 loans, and then assigned risk weightings based on the category and their loan-to-value. There are various concerns related to this issue, but the banks that would be most impacted are those with more junior liens, HELOCs and balloon loans.

Contemplate the Logistics of Compliance

Speak now …

It is vital that community bankers be heard. Regulators need to understand how the proposed changes will impact your business. If you have not yet provided your feedback, please note the comment period is scheduled to expire Oct. 22. Industry trade groups and state banking organizations are mobilized on this issue and can simplify the process of getting your comments to the right people.

Kevin Doyle is senior vice president in the capital markets group at Country Club Bank, Kansas City. Contact him at kdoyle(at) or 800-288-5489.

Copyright (c) October 2012 by BankNews Media