2014 - how does basel iii impact you?
DESCRIPTION
This presentation discusses the impact of Basel III capital, liquidity, and reporting requirements on banking and non-banking organizations and what these organizations can do to prepare for the changes.TRANSCRIPT
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How Does Basel III Impact You? Presented by: Michael Trickey, CPA
Managing Director
Berkshire Advisors, LLC
553 Capital Drive, Lake Zurich, IL 60047 847-540-6554 www.BGLP.com
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“You never want a serious crisis to go to waste.”
“And what I mean by that, it’s an opportunity to do things you think you could not do before”
-- Rahm Emanuel
“All great changes are preceded by chaos.”
-- Deepak Chopra
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Agenda
• Overview of Basel III
• U.S. implementation of Basel III
• Details of Basel III
• Interaction of Basel III with Dodd-Frank Act
• Implications of Basel III changes
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OVERVIEW OF BASEL III
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What is Basel III? Basel III is the third installment of the Basel Accords (meetings held in Basel Switzerland), developed by the Basel Committee of Banking Supervisors (BCBS) Includes regulators from 26 countries, including U.S. Federal Reserve, FDIC and OCC participate on BCBS • Developed in response to deficiencies in financial regulation revealed in late-
2000s financial crisis • Purpose –
• Strengthen bank capital (better quality and risk buffers) • Decrease bank leverage (enforce minimum ratios of
regulatory capital to total on and off-balance sheet exposures)
• Increase bank liquidity positions (both short-term and longer-term)
• Improve disclosures
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Basel III – Promulgation and Adoption
• BCBS introduced Basel III in December 2010, further developed it in June 2011, and have continued to issue updates
• U.S. regulators
• Initially adopted revised capital rules in July 2013
• Ongoing updates in conjunction with BCBS updates
• Largely making refinements and introducing liquidity rules
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U.S. IMPLEMENTATION OF BASEL III
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Covered “Banking Organizations”
• US Basel III generally applies to “Banking Organizations” as follows:
• National banks
• State member banks
• State nonmember banks
• U.S. bank holding companies (BHCS) other than small BHCs
• State savings associations
• Federal savings associations
• Covered savings and loan holding companies (SLHCs)
• Any of the above that are subsidiaries of foreign banks
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Scope of Coverage Differs Among Subcategories of Covered Organizations
• U.S. Globally Systemically Important Banks (G-SIBs)
• Advanced Approaches Insured Depository Institution (IDI) Subsidiaries of G-SIBs
• U.S. Systematically Important Financial Institutions (SIFIs)
• Advanced Approaches Banking Organizations
• Market Risk Banking Organizations
• Banking Organizations - distinctions by asset size:
• >= $50 billion
• >= $15 billion
• >= $10 billion
• >= $500 million
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Definitions • G-SIBs - Top tier BHCs having > $700 billion in total
consolidated assets or > $10 Trillion in assets under custody and Advanced Approaches IDI subsidiaries of any such BHC.
• SIFIs –Banking organizations (and non-banking organizations designated by SFOC) having > $50 billion in total consolidated assets
• Advanced Approaches Banking Organizations: 1) mandatory “core” banking organizations having consolidated total assets of $250 billion or more, consolidated on-balance sheet foreign exposure of $10 billion or more, or are a subsidiary of a core bank, and 2) those that voluntarily apply the advanced internal ratings approach for credit risk and the advanced measurement approach for operational risk
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G-SIBs, Advanced Approaches and SIFIs
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Asset
Rank
Banking
Organization
3/31/2014 Total
Assets ($BIL)
3/31/2014
Custody Assets
($BIL)
Adv'd
Apprch
Banking Orgs
G-SIB
Flag
1 JPMorgan Chase $2,477 20,388$ 1 12 Bank of America $2,153 127$ 2 23 Citigroup $1,895 10,719$ 3 34 Wells Fargo $1,547 666$ 4 45 Goldman Sachs $916 -$ 5 57 Morgan Stanley $831 6$ 6 6
11 US Bank $371 990$ 712 Bank of NY Mellon $368 20,595$ 8 713 PNC $324 86$ 914 HSBC $309 24$ 1015 Capital One $291 3$ 1116 State Steet $257 20,058$ 12 818 TD Bank $237 10$ 19 BB&T $185 $ 10 20 Suntrust $180 64$ 21 American Express $151 -$ 1322 Ally Bank $148 -$ 25 Fifth Third $130 240$ 27 RBS Citizens $127 $ 5 28 Regions $118 17$ 29 BMO Harris $114 127$ 30 Santander $109 -$ 31 Union Bank $107 122$ 32 Northern Trust $104 4,319$ 1433 KeyCorp $91 42$ 34 M&T $89 62$ 35 Bank of the West $85 0$ 36 Discover $80 -$ 37 BBVA Compass $75 2$ 38 Deutsche Bank $73 37$ 39 Comerica $66 52$ 40 Huntington $61 49$ 41 Zions $56 2$
Special CategorySize Indicatiors
Non-Banks Designated as Systemically Important:
Asset
Rank
Banking
Organization
3/31/2014 Total
Assets ($BIL)
3/31/2014
Custody Assets
($BIL)
6 MetLife $891 -$
8 Prudential Financial $747 -$
9 AIG $54725$
10General Electic
Capital Corp$517
-$
Size Indicatiors
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DETAILS OF BASEL III
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U.S. Roll-out Key Provisions
1. Revised Definition of Regulatory Capital 2. Capital Buffers 3. Risk-Weighted Assets 4. Leverage Ratio 5. Liquidity 6. Disclosures 7. Prompt Corrective Action (PCA) Thresholds adjusted
8. Codifies rules into a harmonized integrated regulatory framework
9. Roll-out 1. Starts 1/1/2014 for Advanced Approaches 2. Starts 1/1/2-15 for all others 3. Phase-in of some items
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Final Rule - Basel III Minimum Capital Requirements
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NewCommon Equity Tier 1:
Common Equity Tier 1:Countercyclical Buffer (if deployed)
Common Equity Tier 1:Capital Conservation Buffer
Prior
Tier 2
Tier 2Additional Tier 1
Tier 1Common Equity Tier 1
New Minimum
Transitional Period
* New Adequately Capitalized Minimums
Minimum Capital Requirements
Global Systematically Important Banks (G-
SIB) Surcharge
(core and restricted
capital elements, with
common equity as
"dominant" form)
6% Tier 1
Capital*
Advanced Approaches
Banking Organizations only
Being addressed now;
U.S.more stringent than BCBS
8% Total
Capital*
4.00%
4.00%
1% - 4.5%
0% - 2.5%
4.5%*
1.50%
Failure to maintain a buffer of
at least 2.5% results in
limitations on dividends and
executive bonuses
2.00%
2.50%
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Payout Limitations Based on Size of Capital Conservation Buffer
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Maximum Payout Ratio Size of Buffer
as % of Eligible Retained Income (% of RWA)
No Limit Greater than 2.5
60 >1.875 to 2.500
40 >1.125 to 1.875
20 >0.625 to 1.250
0 <= 0.625
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Calculation of Capital Ratios
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Well Capitalized
Adequately Capitalized
Risk Based Capital Ratio %
Regulatory Capital
= -----------------------------------
Risk-Weighted Assets
CET1 Capital Ratio %
CET1 Capital
= ----------------------------------- = 6.50% 4.50%
Risk-Weighted Assets
Tier 1 Capital Ratio %
Tier 1 Capital
= ----------------------------------- = 8.00% 6.00%
Risk-Weighted Assets
Total Capital Ratio %
Tier 1 + Tier 2 Capital
= ----------------------------------- = 10.00% 8.00%
Risk-Weighted Assets
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Regulatory Capital • Common Stock plus surplus • Retained Earnings • AOCI • CET1 Minority Interests • Less:
• Goodwill, net of DTLs • Securitization gains • Gains (losses) on certain cash flow hedges • Insignificant investments in Financial institutions • Other CET1 deductions
• Threshold deductions , net of DTLs
• CET1 • Additional Tier 1 capital items and deductions
• Tier 1 • Tier 2 capital items and deductions
• Tier 2 • Total Regulatory capital
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Risk-Weighted Assets (RWA)
• Each Balance sheet asset amount x RWA Factor
• Each Non-balance sheet exposure x credit conversion factor x RWA factor
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Minimum Leverage Requirements
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New
Enhanced Supplementary Leverage
Buffer
New US Top Tier BHCs only
Supplementary Leverage Ratio (SLR)
Adequately Capitalized Minimum
Applies to Advance Approaches Banking
Organizations
Generally Applicable Leverage Ratio
Adequately Capitalized Minimum
Applies to all US Banking Organizations
3.00%Advanced Approaches
Banking Organizations only
4.00%
2.00%
Failure to maintain a buffer of
at least 2.0% results in
limitations on dividends and
executive bonuses
Minimum Leverage Requirements
- U.S. Top Tier BHC defined as having > $700 billion in total consolidated assets or > $10 trillion in assets under custody and any
Advanced Approaches IDI subsidiary of such BHCs
- The Supplementary Leverage Ratio includes many off-balance sheet exposures in its denominator; the Generally Applicable
Leverage Ratio does not
- The Supplementary Leverage Ratio = Tier 1 Capital / Total Leverage Exposures (incorporates off-balance sheet exposures)
- The Generally Applicable Leverage Ratio = Tier 1 Capital / Average Total Consolidated Assets
Advanced Approaches Subsidiary IDIs of
US Top Tier BHCs BufferNeed 6% SLR to be Well
Capitalized1.00%
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Payout Limitations Based on Size of Leverage Buffer for Top Tier US BHCs and their Advanced
Approaches IDI Subsidiaries
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Maximum Payout Ratio Size of Buffer
as % of Eligible Retained Income (% of RWA)
No Limit Greater than 2.0
60 >1.500 to 2.000
40 >1.000 to 1.500
20 >0.500 to 1.000
0 <= 0.500
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PCA Capital and Leverage Thresholds
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PCA Threshold Requirements
PCA Capital Category Common Equity
Tier 1 RBC %
Tier 1 Risk-Based Capital (RBC) Total
RBC %
Generally Applicable Tier 1
Leverage (percent)
Supplementary leverage ratio for advanced approaches banking organizations %
Supplementary leverage ratio for subsidiary IDIs of
top-tier US BHCs % Current %
Interim Final Rule %
Well Capitalized ≥ 6.5 ≥ 6.0 ≥ 8.0 ≥ 10.0 ≥ 5.0 Not applicable >= 6
Adequately Capitalized ≥ 4.5 ≥ 4.0 ≥ 6.0 ≥ 8.0 ≥ 4.0 >= 3 >= 3
Undercapitalized < 4.5 < 4.0 < 6.0 < 8.0 < 4.0 < 3 < 3
Significantly undercapitalized < 3.0 < 3.0 < 4.0 < 6.0 < 3.0 Not applicable Not applicable
Critically undercapitalized Tangible Equity to Total Assets ≤ 2%
Not applicable Not applicable
- Revised PCA ratios are effective on January 1, 2015, for all banks
- Tangible Equity equals the revised Tier 1 Capital plus outstanding non-Tier 1 perpetual preferred stock
- The Supplementary Leverage Ratio includes many off-balance sheet exposures in its denominator; the generally applicable leverage ratio does not
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Liquidity Coverage Ratio
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Stock of high quality liquid assets (HQLAs)
Net cash outflows over a 30-day time period>= 100%
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Net Stable Funding Ratio • Longer term Funding
• NSFR =
• Available Stable Funding (ASF)/ Required Stable Funding (RSF)>100%
• ASF – available reliable sources of funds over a 1-year period under
conditions of extended stress • Tier 1 and Tier 2 capital, preferred stock with maturity > 1 year, liabilities with
maturity > 1 year, stable deposits and funding with maturities < 1 year.
• Each weighted according to perceived availability and stability
• RSF – sum of the various types of various types of assets held and funded by a bank and off-balance sheet contingent exposures incurred and other bank activities that could expose it to liquidity risk • Each weighted according to perceived likelihood of funding needs
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Disparate Rules and Impacts
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Asset
Rank
Banking
Organization
Adv'd
Apprch
Banking Orgs
G-SIB
Flag
Revsd
Cap'l Rule,
w/ revsd
RWAs
Grand-
fathered
Cap'l
Items
AOCI
Opt-
out
CET1
Cap'l
Cnsvtn
Buffer
CET1
Counter-
cyclical
Buffer
CET1 G-
SIB Sur-
charge
LR SLR eSLR LCRMod
LCRNSFR
CCAR
BHCs
CapPR
BHCs
Annual
Firm-run
Stress
Tests
D-FAST -
1 Mid-
cycle, 2
annual
Living
Will
1 JPMorgan Chase 1 1 x x 1 1 x 1 1 1 TBD 1 1 1
2 Bank of America 2 2 x x 2 2 x 2 2 2 TBD 2 2 2
3 Citigroup 3 3 x x 3 3 x 3 3 3 TBD 3 3 3
4 Wells Fargo 4 4 x x 4 4 x 4 4 4 TBD 4 4 4
5 Goldman Sachs 5 5 x x 5 5 x 5 5 5 TBD 5 5 5
7 Morgan Stanley 6 6 x x 6 6 x 6 6 6 TBD 6 6 6
11 US Bank 7 x x 7 x 7 7 TBD 7 7 7
12 Bank of NY Mellon 8 7 x x 8 7 x 8 7 8 TBD 8 8 8
13 PNC 9 x x 9 x 9 9 TBD 9 9 9
14 HSBC 10 x x 10 x 10 10 TBD 1 10 10
15 Capital One 11 x x 11 x 11 11 TBD 10 11 11
16 State Steet 12 8 x x 12 8 x 12 8 12 TBD 11 12 12
18 TD Bank x x x x 1 TBD 12 13 13
19 BB&T x x x x 2 TBD 12 14 14
20 Suntrust x x x x 3 TBD 13 15 15
21 American Express 13 x x 13 x 13 4 TBD 14 16 16
22 Ally Bank x x x x 5 TBD 15 17 17
25 Fifth Third x x x x 6 TBD 16 18 18
27 RBS Citizens x x x x 7 TBD 2 19 19
28 Regions x x x x 8 TBD 17 20 20
29 BMO Harris x x x x 9 TBD 3 21 21
30 Santander x x x x 10 TBD 22 22
31 Union Bank x x x x 11 TBD 4 23 23
32 Northern Trust 14 x x 14 x 14 12 TBD 5 24 24
33 KeyCorp x x x x 13 TBD 18 25 25
34 M&T x x x x 14 TBD 6 26 26
35 Bank of the West x x x x 15 TBD 13 27 27
36 Discover x x x x 16 TBD 7 28 28
37 BBVA Compass x x x x 17 TBD 8 29 29
38 Deutsche Bank x x x x 18 TBD 14 30 30
39 Comerica x x x x 19 TBD 9 31 31
40 Huntington x x x x 20 TBD 10 32 32
41 Zions x x x x 21 TBD 11 33 33
Banking Orgs $15 bil >=
assets < $50 bilx x x x x
Banking Orgs $10 bil >=
assets < $15 bil x x x x x x
Banking Orgs with
total assets < $10 bilx x x x x
Capital Rules, with Revised RWAs Leverage Ratio LiquidtySpecial Category CCAR BHCs DFA Items
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IMPLICATIONS OF BASEL III CHANGES
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What to do now? • Take inventory – where do we stand now?
• May require extensive disaggregation of data into new RWA, liquidity, capital and leverage categories (now 17 RWA categories) • Requires reading and interpreting hundreds of pages of regulator documents
• Systems may require updates and programming to accommodate new categories
• Changes to call reports are extensive, especially to Schedule R (regulatory capital and risk weighted assets [stay tuned])
• Organization structure and oversight committees
• Run current numbers through new paradigm model • If we do nothing, are we in or out of compliance • What are the best methods to improve the picture ?
• Giant puzzle - Linear programming model • Objective function – (e.g., maximize profits) • Variables (balances, rates, risk-weightings, etc.) • Constraints (minimum and maximum ratios,) • Run optimizations
• Benefits if you do something versus risks of doing nothing 26
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What to Consider? • Options to consider:
• Capital: • Determine whether you should Opt-Out of AOCI changes • Replace non-qualifying forms of capital with qualifying forms • Raise new capital in qualifying forms • Divest of assets that are deductions from CET1
• Assets • Discontinue marginally profitable activities involving highly risk-weighted assets or
illiquid assets • Divest of assets with high RWA factors • Focus on high quality liquid assets • Collateralize more transactions
• Off-balance sheet items • Change form of unfunded commitments, and trim excess commitment amounts • Highly scrutinize counterparties and guarantors • Evaluate differing forms of structured transactions
• Funding sources and types • Lengthen maturities of deposits and debt • Put more emphasis on stable forms of funding
• Mergers and Acquisitions • Understand the Basel III- related ramifications of any transaction
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Strategic Questions • How will phasing in of new requirements affect my growth and business plans?
• How long does each potential strategy I might pursue take to implement versus how much time I have to be in compliance?
• What are the trade-offs between yield, fees, and capital charges that I need to consider to maintain an acceptable ROE and have no dividend or bonus restrictions?
• What Implementation costs will I face and can I pass any of these costs on to my customers directly or through other revenue sources?
• To what extent will the market impose uniform standards on all types and sizes of entities, regardless of disparate regulatory adoption requirements and timelines?
• Basel III is important, but just one piece of the puzzle that needs to be considered:
• How do Basel III, Dodd-Frank, QM, QRM, CFPB, Regulation AB, massive lawsuit settlements, and other market changes and dynamics interact?
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Real World Case Study Examples
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Systems and Record-Keeping • Increased complexity requires more granularity in general ledger and
systems of record:
• More categories: • Risk-weighted assets, high quality liquid assets, funding maturities and types,
investments, off-balance sheet items, capital instruments
• Call reports have many more pages, fields and inter-relationships to track and program systems
• Systems will need to support extensive new internal and external reporting needs
• Planning and forecasting systems will need to be programmed
• Compliance and profitability trade-offs must be examined
• Need way of tracking and matching counterparties and guarantors to assets
• Need tighter scrutiny of commitments – excess amounts will be a drain on capital
• Increased regulator scrutiny and reporting requirements
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Capital Ratio Implications • Multi-prong approach may be necessary:
• Raise new capital or replace existing non-qualifying capital
• Reduce assets that are direct reductions of capital
• Alter asset mix to encompass lower risk-weighted assets
• Increasing capital may:
• Reduce funding costs (less debt)
• Increase net income
• But at a reduced ROE
• Capital ratios, leverage ratios, and liquidity ratios need to be considered in unison
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Shedding Assets Causing Deductions From Capital
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Source: www.globes-online.com 8-7-2014
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Selling MSRs – Strong price and Improved Capital Ratios
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Selling MSRs removes an asset that causes a in dollar-for-dollar reduction in CET1 for assets amounts above the 10% or CET1 limit. It also reduces RWAs, as the 10% piece not resulting in CET1 reduction is subject to a 250% risk-weighting.
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Implications on customer ownership, customer service, and cross-selling opportunities
• Certain activities will move toward the less regulated shadow banking sector as the regulatory cost to banks to undertake such activities increases
• The interconnectedness of banks with nonbank entities will be challenged by supervisors
• Key example is mortgage servicing assets:
• Basel III has let to an increasing concentration of servicing held by less regulated, non-bank firms such as mortgage companies, REITs, hedge funds, and private equity firms that are not subject to the new capital restrictions.
• Banks are either selling loans servicing released or selling servicing rights separately
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One strategy - Banks can sell MSR assets but retain subservicing to keep customer relationships
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FHFA Using Approval Rights as One Means of Control
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NY DFS is Delaying Transactions
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Risk-Weighted Asset Implications
• Increased risk weighting on certain on and off-balance sheet exposures has a dual impact on capital ratios and liquidity ratios
• First goal is to see determine which exposure provide greatest boast in both ratio types through their elimination
• Rank by impact
• Examine profitability of each
• Take strategic actions to shed high capital and liquidity cost, low cash return assets
• MSRs
• Stock and debt in other financial institutions
• High Velocity Commercial Real Estate Assets
• Excessive unused commitments
• Certain trading assets and derivative exposures
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Implications on Business Lines – Reducing Marginally Profitable Assets to Meet Leverage Ratios
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Implications on Commitments
• Reduction in size of commitments
• Efforts to make commitments unconditionally cancellable where practical
• Unconditionally cancellable commitments have a O% risk weighting for capital ratios but 10% for liquidity ratios
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Implications on Product Design
• Transform unsecured credit into credit secured by collateral such as real property or cash
• Shift certain customers from credit products to debit products
• Transform long credit exposure durations (grace periods, billing cycles, credit limits) into shorter durations, particularly for non-revolving customers
• Transform contingent liabilities, especially unused credit lines (even internal guidance lines), into just in time, or case by case, underwriting
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Liquidity Ratio Implications • Institutions are encouraged to put liquid assets and longer-term
funding on balance sheet
• Challenge is the liquid assets yield less and longer-term funding costs more
• Combined with higher capital needs, ROEs can suffer
• Banking organizations are meeting the challenge by cutting low margin businesses that have high risk-weighting or that involve very short-term funding
• Retail units that raise deposits (viewed as stable funding) can gain greater emphasis
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Implications on Business Lines – Cutting Certain Types of Lending to Meet Liquidity Ratios
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The letter asks these so-called “stock borrow transactions” not to be classified as loans by the bank for the purposes of the new funding rules.
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Implications on Growth and M&A • Growth by acquisition may lead to greater and more onerous
requirements:
• Loss of grandfathering of TruPS and other capital instruments if growth is through acquisition
• AOIC Opt-out election status of combined entities
• Combined entity may move into a new asset-size bracket and the resulting increase in capital, reporting and stress testing requirements
• Desire not to just edge into new category
• > $10 billion, > $50 billion, Advanced Approaches
• Goodwill in a transaction results in a dollar-for-dollar reduction in CET1
• Generic growth may also result in some of these issues
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Growth into New Asset Size Category Affects Plans
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Source: Wall Street Journal 7-22-2014
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Systemically Important Tag Draws Ire from Large Regional Banks
46 Source: Wall Street Journal, July 31, 2014
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FSOC Designates MetLife as Systemically Important on 9-4-2014 – Subjects Company to Stress Tests and Living Will Requirements
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Competitive Comparative Analytics discussion
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COMPARATIVE FINANCIAL ANALYSIS
CCF
Factor
Risk
Wtg
Banking Org
< $15 billion
Banking Org
>=$ 15 bil <
$50 bil
Banking Org
>=$ 50 bil <
$250 bil
Banking Org
>=$ 250 bil <
$700 bil
G-SIB
Banking Org
Small
Mortgage
Company
Large
Mortgage
Company
REIT
1. Cash and balances due from
depository institutions 0%
2. Securities excluding securitization
exposures
a. Held-to-maturity securities
b. Available-for-sale securities
3. Federal funds sold and securities
purchased under agreements to
resell
4. Loans and leases held for sale
a. Residential mortgage exposures50%
b. High volatility commercial real
estate exposures 150%
c. Exposures past 90 days or more
or on nonaccrral 100%
c.1 1-4 family mortgage 100%
c.2 Other exposures 150%
d. All other exposures 100%
5. Loans and leases, net of unearned
income…
a. Residential mortgage exposures50%
b. High volatility commercial real
estate exposures 150%
Completed analysis will be Discussed in Presentation
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Berkshire Group Contacts
49
The Berkshire Group is a management consulting firm providing advisory services, predictive analytics, due diligence services and data subscription products to banking organizations and other financial institutions. For more information, please visit www.bglp.com. If we can be of assistance to your organization, please contact one of the parties below:
Michael W. Trickey Managing Director O: 847-540-6554 x204 C: 847-867-3595 Email: [email protected]
Jim Reynolds Senior Director C: 415-971-0026 Email: [email protected]
Debra Vander Weit Consulting Director O: 847-540-6554 x206 C: 847-867-3595 F: 847-540-6548 Email: [email protected]
David Stinner Director O: 301-216-9776 C: 301-908-1531 Email: [email protected]
Berkshire Group LP 553 Capital Drive Lake Zurich, IL 60047 O: 847-540-6554 Email: [email protected] Web: www.bglp.com