1.02.new and proposed fca guidance final2districtaccountingconference.weebly.com/uploads/9/...may...

May 2014

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Regulation Changes that Impact You

New and Proposed FCA Guidance

Abby Wegner, Director of Financial Reporting

Angie Moldestad, Senior Financial Reporting Analyst

May 13, 2014

• Senior Officer Compensation Disclosures – Recent Updates

• Regulatory Capital Changes on the Horizon

DISTRIBUTION: AGRIBANK DISTRICT

Agenda

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Discussion regarding changes to Regulatory Capital Ratios is based onexpectations from participants in the System Work Group prior to the

May 8, 2014 action by FCA. Information is consistent with thatpresented at the 2013 AgriBank CFO Conference as no further updates

have been discussed.

May 2014

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Senior Officer Compensation DisclosuresRecent FCA updates

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• On March 13, 2014 the FCA Board approved an interim final rule toremove all requirements related to nonbinding, advisory votes atFarm Credit System institutions.

• The interim final rule removes only the requirements related tononbinding, advisory votes.

• Other recently implemented rules related to Senior OfficerCompensation remained in affect:– Enhanced transparency of compensation disclosures for CEOs and senior officers

– Enhanced responsibilities of the Compensation Committee of the Board ofDirectors

AgriBank District and Association Annual Reports issued on or after March 13, 2014modified the ‘Information Required by Regulations’ section for this change.

All AgriBank District and Association Quarterly Reports prepared by AgriBank FinancialReporting modified the Q1 2014 MD&A to notify shareholders of the change.


Regulatory Capital Changes on the HorizonBackground

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• Why are capital requirements changing?– Basel III is a result of the financial crisis in 2008; regulators believe one of the

reasons for the crisis was inadequate capital reserves at many financialinstitutions

– Enhanced comparability of Farm Credit System capital to commercial bankswhich may alleviate some of the perceived premium on System third partycapital (subordinated debt and preferred stock)

• Capital Work Group representing System institutions is coordinating withFCA

• Guiding Principles of the Capital Work Group:– FCA’s revised capital framework must not adversely impact the FCS’s cooperative

business model– FCA should not get ahead of other regulators’ capital rulemakings– Implementation of a Basel III framework for the FCS should focus on

permanency of capital available to absorb losses

May 2014

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• Common Equity Tier 1 (CET1): Highest quality capital,must be the predominant form of Tier 1 capital

• Additional Tier 1 Capital: Must meet specific criteria;absorbs losses without the institution becoming insolvent

• Tier 2: Absorbs losses in insolvency before other creditors

• Non-risk-based Leverage Ratio: Backstop to risk-basedmeasures


Regulatory Capital Changes on the HorizonPrimary Capital Measures

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• Risk Adjusted Capital Ratios

• Leverage Ratio

CONFIDENTIAL


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Common Equity Tier 1 Capital / Risk Adjusted Assets

Tier 1 Capital / Risk Adjusted AssetsTier 1

Capital Ratio

Total Capital / Risk Adjusted AssetsTotal Capital

Ratio

Tier 1 Capital / AssetsTier 1

Leverage

CommonEquity Tier 1

Ratio

May 2014

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• Overview of Potential Capital Requirements

*Subject to determination by FCA

– Common Equity Tier 1 and Tier 1 Capital Ratio (excluding Conservation Buffer)targeted for 2015 implementation

– Total Capital Ratio (excluding Conservation Buffer) 8.5% - no phase-in date

Total Capital Ratio Subordinated Debt

Tier 1 Capital Ratio Non-cumulative Preferred Stock

Capital Conservation Buffer

Common Equity Tier 1 Ratio Allocated Surplus*Nonqualified Allocated Surplus*Unallocated Retained EarningsAssociation Investment in District Bank*Paid-in-CapitalCommon Stock-Protected*Common Stock-Allocated*Common Stock-Purchased

10.5%

8.5%

7.0%

4.5%

• Capital Conservation Buffer required above the minimum capital requirement in

Basel III to lessen bank vulnerability to financial cycles

• If the buffer falls short of the 2.5% requirement, association/bank is subject to

restrictions on payout in form of patronage or discretionary bonus payments as

a percent of eligible retained income, as shown in the table below



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• The maximum payout amount would be calculated as of the last day of the prior

quarter and restrictions applied during the current quarter.

– Notwithstanding the above, agencies retain their authority to permit banks to make

capital distributions or discretionary bonus payments consistent with safety and

soundness.

Capital Conservation Buffer Maximum Payout RatioGreater than 2.5% No Limitation

1.875% < CCB <= 2.5% 60%

1.25% < CCB <= 1.875% 40%

0.625% < CCB <= 1.25% 20%

Less than or equal to 0.625% 0%

May 2014

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Regulatory Capital Changes on the HorizonImpact to Risk Adjusted Assets

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• Adjustments to Risk Adjusted Assets (RAA)– Residential Mortgage Loans – Maintains current treatment (50%)

– Rural Electric Loans – Risk-weight may increase – TBD (currently 50%)

– Loans Past Due 90+ and Nonaccrual Loans – Risk-weight 150% (currently100%)

– Retail Unfunded Commitments < 14 mo – Risk-weight 20% (currently notincluded)

– Certain acquisition development and construction loans – Risk-weight 150%(currently 100%)

• Basel III Approach: Final Rule resorts back to current practice– 50% risk weight for prudently underwritten residential mortgages

– 100% for other residential mortgages and Nonaccrual loans or past due 90+days loans

– More regulations expected

• Implication to FCS: Most rural home loans today are 50% riskweighted

• Workgroup Recommendation: Adopt the Basel III approach

• Estimated Impact on RAA: Impact is a very little to modestincrease in RAA– Less than 50bps increase to RAA on average

– 13 associations have greater than a 1% increase in RAA (1.2% - 7.8%)

– 10 of these are in the AgFirst District


Regulatory Capital Changes on the HorizonRisk Weight: Rural Residential Mortgages

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May 2014

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• Preparation by AgriBank Financial Reporting:– Project Implemented in October 2013 to capture via Hyperion member

rather than memo accounts

• Other Potential Changes:– Additional bifurcation will be needed for delinquency and accrual status for

all Rural Residential Mortgages – exists in Hyperion District Reporting Cube,but does not exist in the Hyperion Finance Cube

– Modification of Monthly Management Report Model, Shareholder ReportModel, and related Hyperion members to reflect the change in riskweighting


Regulatory Capital Changes on the HorizonRisk Weight: Rural Residential Mortgages

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• Basel III Approach: Not specifically addressed; therefore, woulddefault to 100% risk weighting

• Implication to FCS: Currently the FCA allows 50% weighting for asignificant portion of loans to Rural Electric Co-ops

• Workgroup Recommendation: Preserve the 50% weighting giventhe low risk profile of these loans

• Estimated Impact on RAA: The risk weighting would double forthose System institutions with Rural Electric loans.– 28 associations have rural electric exposures and their RAA would increase

by 0.5% on average (range from 0.2% to 1.5%)

– Eight Associations in AgriBank District affected


Regulatory Capital Changes on the HorizonRisk Weight: Rural Electric Loans

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May 2014

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• Preparation by AgriBank Financial Reporting:– Project Implemented in October 2013 to capture via Hyperion member

rather than memo accounts

• Other Potential Changes:– Modification of Monthly Management Report Model, Shareholder Report

Model, and related Hyperion members to reflect the change in riskweighting


Regulatory Capital Changes on the HorizonRisk Weight: Rural Electric Loans

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• Basel III Approach: Loans (excluding residential mortgages loans)90+ days past due or in nonaccrual must be risk weighted 150%– Portions secured by financial collateral may be assigned a risk weight

applicable to that collateral (e.g., 0% for cash collateral)

• Implication to FCS: An increase in the risk weight for past due andnonaccrual loans as the current risk weight is 100%.

• Workgroup Recommendation: Adopt Basel III approach

• Estimated Impact on RAA: Modest increase in RAA given theSystem’s generally low level of nonperforming loans– Increase in RAA of 0% - 5% with an average of 0.3% for Banks and 0.8% for

Associations.


Regulatory Capital Changes on the HorizonRisk Weight: Loans Past Due 90+ and Nonaccrual Loans

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May 2014

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• Preparation by AgriBank Financial Reporting:– Project Implemented in May 2014 to capture via Hyperion member rather

than memo accounts

• Other Potential Changes:– Identification of delinquency by collateral type

– Modification of Monthly Management Report Model, Shareholder ReportModel, and related Hyperion members to reflect the change in riskweighting


Regulatory Capital Changes on the HorizonRisk Weight: Past Due and Nonaccrual

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• Basel III Approach: 20% weighting for unfunded commitments<12 months; 50% for >12 months; 0% weighting forunconditionally cancelable commitments– Unconditionally Cancelable Commitments: commitment where funding may

be withheld for any reason and without cause

• Implication to FCS: Change will increase RAA. Current riskweighting is 0% for unused commitments with original maturity<14 months; 20% for trade-related contingencies; 50% for unusedcommitments >14 months

• Workgroup Recommendation: Adopt Basel III approach, butextend definition of short term commitment to <14 months

• Estimated Impact on RAA (assuming 14 month break point):Increases RAA for all System institutions.– Ranges from an RAA increase of less than 0.25% to about 10% at CoBank

– On average, associations seem to have about a 2% increase in RAA


Regulatory Capital Changes on the HorizonRisk Weight: Retail Unfunded Commitments

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May 2014

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• Preparation by AgriBank Financial Reporting:– Project Implemented in October 2013 to capture Unfunded Commitments

less than 14 months

– Project has provided a completeness check to Total Commitments

• Other Potential Changes:– If FCA uses the Basel III threshold of 12 months, Hyperion logic will need to

be revised and likely new Hyperion members will need to be created


Regulatory Capital Changes on the HorizonRisk Weight: Retail Unfunded Commitments

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• Unless specifically identified, loans are risk weighted 100%

• High Volatility Commercial Real Estate Loans – 150%

– Exception for agricultural land if valuation based on agriculturaluse and does not take into account potential non-agriculturaluse

– FCA will look for “curbs and utilities” in timber loans


Regulatory Capital Changes on the HorizonRisk Weight - Other

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May 2014

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• Preparation by AgriBank Financial Reporting:– No Changes to Date

• Other Potential Changes:– If High Volatility Commercial Real Estate Loans need to be bifurcated and

risk weighted differently, this will require a project to identify appropriatecoding in the loan system, development of Hyperion members, and likelyupdates/changes to all Financial Reporting Models used in the BusinessService


Regulatory Capital Changes on the HorizonRisk Weight - Other

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• Basel III approach: Detailed on next slide

• Implication to FCS: Detailed on following slide

• Workgroup Recommendation: Follow Basel III and eliminateprovisions that are clearly not applicable to FCS. Initial reviewindicates only two risk weights are applicable to Systeminstitutions: (1) 20% risk weight for GSE equity investments (i.e.,Farmer Mac); and (2)100% risk weight for equity exposures notsubject to numerator deduction and adjustment provisionsrelating to intra-System investments in unconsolidated financialinstitutions (i.e., banks and associations).

• Estimated Impact on RAA: Insignificant impact today.


Regulatory Capital Changes on the HorizonEquity Exposures

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May 2014

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Regulatory Capital Changes on the HorizonEquity Exposures

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Investment Current FCA Regs Basel IIIFarmer Mac Common 20% risk weight 20% risk weight

100% RW for Preferred Stock425 Service Corp Full deduction

§615.5207(f)100%

Funding Corporation 20% 100%Captive Insurer 100% 100%Building Association 100% (akin to premises

& equip)615.5211(d)(5)

100%

AgDirect(associated with lending soshould be full deduct)

Full deduction Full deduction

Unincorporated BusinessEntities

100% 100% (non‐significant equity exposures)

Rural Bus Invest Co 100% 100% (akin to communitydevelopment fund & SBIC)

Rural Equity Fund 100% 100% (akin to communitydevelopment invest & non‐ significant exposures)

• Basel III approach: Complex requirements around significant and non-significant investments in unconsolidated financial institutions (i.e., banks andassociations)

• Implication to FCS: Significantly favorable given under Basel III deductions arealways less than the current requirement for full deduction

• Workgroup recommendation: Continue with current regulatory approach offull deduction of Intra-System investments between banks and associationsgiven the interconnected and financial interdependency of the System

• Estimated impact on RAA: None, based on workgroup recommendation


Regulatory Capital Changes on the HorizonInvestments in Unconsolidated Financial Institutions

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Investment in: FCA Regs Propose for new RegsAssn investment in Bank Full deduction Full deduction

Bank investment in Assn Full deduction Full deduction

Bank investment in Bank Full deduction Full deduction

May 2014

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Preliminary & Estimated Risk Adjusted Assets (data from June 30, 2013)


Regulatory Capital Changes on the HorizonPotential Impact to Associations

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-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

Risk Adjusted Assets - Current

Risk Adjusted Assets - Basel III

GreenStone

ACAAgStar

ACA

NorthDakota

ACA Delta ACAMandan

ACA

FarmCreditIllinois

ACA

FCS ofAmerica

ACAMidsouth

ACA

WesternArkansas

ACABadgerland

ACAAgHeritage

ACAProgressive

FCS, ACAAgCountry

ACA

1st FarmCredit

Services,ACA

UnitedACA

FCSFinancial,

ACA

FarmCreditMid-

AmericaACA

1% 4% 1% 3% 3% 2% 5% 3% 0% 1% 3% 2% 1% 2% 1% 1% 2%

• Calculating impact to Permanent Capital Ratio (PCR)

– Assume Association PCR is currently 15.0%

– Due to implementation of new Basel III definitions and riskweights, Risk Adjusted Assets increase by 3.0%

– New PCR = 15/103 = 14.56%

– PCR would decline by .44% due to changes in RAA


Regulatory Capital Changes on the HorizonPotential Impact to Associations

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May 2014

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• The largest issue for the System is treatment of cooperative capital

• Basel III defines Common Equity Tier 1 based on 13 specific criteria– Some of these criteria are not applicable or not appropriate for cooperative

organizations

• Basel III allows regulators to take into consideration the uniquecharacteristics of cooperative’s capital, and to define conditionsunder which cooperative capital will qualify as Common EquityTier 1

• FCA indicates they view the lesser of 2% or $1,000 purchased stockas Common Equity Tier 1– European regulators have allowed purchased member stock of immaterial

amounts relative to the size of loans to be counted as CET1

• Treatment of allocated equities are to be determined


Regulatory Capital Changes on the HorizonCapital – Cooperative Equities

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• System Cooperative Equities– Allocated stock: allocations of capital stock classes resulting

from patronage distributions– Qualified allocated surplus: earned surplus outstanding that has

been specifically allocated to the reporting institution’sstockholders which resulted from patronage distributions

– Nonqualified allocated surplus: All patronage allocations orother allocations of earnings designated to the institution’sstockholders, and were not deducted from the gross taxableincome of the allocating institution

• Approximately 20%-25% of System Net Worth is comprised ofCooperative Equities– Exclusion of this equity could be detrimental to many Farm Credit

Institutions


Regulatory Capital Changes on the HorizonCapital – Cooperative Equities

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May 2014

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• Basel III Approach: Total Capital includes Allowance for Loan andLease Losses up to 1.25% of Risk Adjusted Assets (part of Tier 2Capital)

• Implication to FCS: Current Regulatory Capital Ratios do not countAllowance as capital

• Workgroup Recommendation: Adopt the Basel III Approach

• Estimated Impact: Under current accounting rules, overall minimalimpact

– AgriBank District Allowance is approximately 0.35% of RiskAdjusted Assets

– Association Allowance as percentage of Risk Adjusted Assetsranges from 0.11% to 0.69% of RAA


Regulatory Capital Changes on the HorizonCapital – Allowance

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• Basel III Approach:

• Implication to FCS: Conceptually similar to current regulatory approach,with Preferred Stock and Subordinated Debt appropriately treated basedon their relative quality for absorbing losses– Noncumulative Perpetual Preferred Stock is currently part of Core Surplus, but it

will not be included in CET1– Subordinated debt receives capital treatment in the NCR, but not in the Basel III

Leverage Ratio

• Workgroup Recommendation: Adopt the Basel III Approach• Estimated Impact: Overall minimal impact in the treatment of third

party capital, except Noncumulative Perpetual Preferred Stock will nolonger be treated as the highest quality capital as it is today andSubordinated Debt will not provide relief for the Leverage Ratio


Regulatory Capital Changes on the HorizonCapital - Preferred Stock and Subordinated Debt

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Perpetual Noncumulative Preferred Tier 1 Capital

Perpetual Cumulative Preferred Tier 2 Capital

Subordinated Debt Tier 2 Capital

May 2014

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Regulatory Capital Changes on the HorizonSummary Potential Impact to Associations

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• Higher capital requirements– Common Equity Tier 1 – 4.5%– Total Capital – 8.0%– Capital Conservation Buffer adds 2.5% to above minimum ratios– Leverage Ratio – 4.0%– Risk-Adjusted Assets will increase (generally)

• Increased financial disclosures and additional data in Call Reportslikely

• Implementation date may be contingent on FCA’s treatment ofcooperative shares– May 8, 2014 FCA Board meeting is expected to take action and provide rules

for comment

DISTRIBUTION: AGRIBANK DISTRICT 30

For questions or comments, please contact:Angie Moldestad at [email protected] or 651-282-8313

Abby Wegner at [email protected] or 651-282-8732

May 2014

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The next presentation will begin in a moment!

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