schedule rc-r: risk based capital - learn.claconnect.com

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CLAconnect.com

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CLAconnect.com

Schedule RC-R: Risk Based Capital Call Report Preparation under BASEL III

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Your Instructor: Amanda Garnett

Amanda Garnett, CPA is a manager with the Financial Institution Group of CliftonLarsonAllen LLP from Peoria, Illinois. She has served in a variety of roles providing community banks with services in the areas of financial statement audits, internal audits, regulatory reporting, tax compliance, and consulting services. She has served clients ranging from $10 million to $5 billion in total assets in Illinois, Iowa, Indiana, Kentucky, Missouri, Arkansas, and Colorado. Amanda currently oversees tax compliance and consulting services for all banks served out of CLA’s downstate Illinois and Missouri offices. In addition, Amanda performs consulting and training for banks across the country in the area of call report preparation.

• Visit us at www.CLAconnect.com.

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http://www.claconnect.com/

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Course Objectives

• Assist community banks obtain an understanding of:

– The new BASEL III regulatory capital standards including the new Common Equity Tier 1 Capital (CET1) ratio

– The revised Prompt Corrective Action (PCA) thresholds

– The new capital conservation buffer and the related impact on bank dividends and bonus payments

– The changes to risk weights for various assets

– The changes to disallowed deferred tax assets under the new rules

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Overview of Regulatory Capital Changes

• Effective date of changes for community banks:

– January 1, 2015

• New call report schedules:

– March 31, 2015 call report

• Resources for community banks:

https://www.fdic.gov/regulations/capital/index.html

• FDIC regulatory capital estimation tool

– Access at the link above to estimate the impact of the changes on your bank’s regulatory capital

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https://www.fdic.gov/regulations/capital/index.html

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Proposed Call Report Revisions

• New Tier 1 and Common Equity Tier 1 calculations can be found in Part 1B of the current call report instructions and forms

https://www.fdic.gov/regulations/resources/call/crinst/callinst2014_jun.html

• The proposed new risk weighted assets table of Schedule RC-R can be found at:


• Draft instructions for the proposed new risk weighted assets table portion of Schedule RC-R can be found at:

http://www.ffiec.gov/pdf/ffiec_forms/FFIEC031_FFIEC041_20140623_i.pdf

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http://www.ffiec.gov/pdf/ffiec_forms/FFIEC031_FFIEC041_20140623_i.pdf

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Overview of the New Reg Cap Rules

• New rules revise regulatory capital definitions and minimum ratios

• Redefines Tier 1 capital as two components

– Common equity Tier 1 capital

– Additional Tier 1 capital

• Creates a new capital ratio:

– Common Equity Tier 1 risk-based capital ratio

• Creates a capital conservation buffer that can limit dividend payouts and bonuses

• Changes risk weightings for certain assets

• Changes the calculation of disallowed deferred taxes

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Common Equity Tier 1 (CET1) Capital Ratio

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Calculating Common Equity Tier 1 Capital

Common Equity Tier 1 Capital =

Common stock and related surplus (net of treasury stock and unearned ESOP shares)

+ Retained earnings

+/- Accumulated other comprehensive income*

+ Qualifying minority interest

+/- Deductions and adjustment

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* On your March 31, 2015 call report- choose “Yes” yo opt out of including other comprehensive income in CET1. This retains the same regulatory capital treatment for OCI as under the current rules. This is a one time election.

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RC-R – Regulatory Capital Page 1

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Deductions to Common Equity Tier 1

• Direct dollar for dollar reduction in capital

• Components

– Goodwill – net of related deferred tax liabilities

– Other intangible assets (Except MSRs) – net of related deferred tax liabilities

– Deferred tax assets associated with net operating loss carryforwards and tax credit carryforwards

◊ Federal NOLs

◊ State NOLs

◊ AMT credit carryforwards

◊ Business credit carryforwards

◊ Net of any valuation allowance recorded

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RC-R – Regulatory Capital Page 1 (cont.)

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Adjustments to Common Equity Tier 1

• Assuming “opt out” election was made

• Direct dollar for dollar adjustment in capital

– To eliminate the impact of these items to regulatory capital

• Components

– AOCI for net unrealized gains/losses on available for sale securities

– AOCI for net unrealized gains/losses on preferred stock – net of related deferred tax components

– AOCI for pension and post-retirement benefits

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Threshold Deductions to CET1

• Deduct amounts > 10% individually or >15% in aggregate of CET1 Capital

• Components

– Mortgage servicing rights – net of related deferred tax liabilities

– Deferred tax assets associated with timing differences that can not be realized through net operating loss carrybacks

◊ Bad debts deduction

◊ Depreciation on fixed assets

◊ Deferred compensation

◊ Net of any valuation allowance recorded

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RC-R – Regulatory Capital Page 2

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Additional Tier 1 Capital

• Line 20 – Additional Tier 1 capital Iistruments plus related surplus

– Noncumulative perpetual preferred stock, including surplus

– Bank Call Report – Includes bank level Tier 1 instruments issued under Small Business Lending Fund (SBLF) and Troubled Asset Relief Program (TARP) capital components

– Form FRY-9C- Includes: Tier 1 TARP, SBLF, and for most community banks TruPs

◊ Trust Preferred Securities (TruPS) Qualifications

• Holding companies with assets less than $15 billion in total consolidated assets as of December 31, 2009 or organized as a mutual as of May 19, 2010 are allowed to grandfather into tier 1 capital.

• TRuPS issued before May 19, 2010 are subject to a maximum of 25% of tier 1 capital.

• Line 21- Non-qualifying capital instruments subject to phase out from additional Tier 1 capital

– Generally applies to institutions over $15 billion that must phase out

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Tier 2 Capital

• Line 27: Tier 2 capital instruments plus related surplus

– Bank Call Report- Includes bank level Tier 2 instruments issued under Small Business Lending Fund (SBLF) and Troubled Asset Relief Program (TARP) capital components

– Form FRY-9C- Includes: Tier 2 TARP, SBLF, and for banks with less than $15 billion in total assets TruPs that exceed the Tier 1 limitation of 25%

– Also includes most subordinated debt

• Line 30a: Limited allowance for loan & lease losses

– Limited to 1.25% of risk weighted assets

– Same as current limits

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RC-R – Regulatory Capital Page 2-3

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Calculation of Capital Ratios

Common Equity Tier 1 RBC Ratio =

Common Equity Tier 1

/ Total risk weighted asset

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Tier 1 Capital Ratio =

Total Tier 1 capital


Total Capital Ratio =

Total capital


Tier 1 Leverage Ratio=

Total Tier 1 capital

/ Total assets for leverage ratio (=avg total assets – adjustments)

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Transition Period of Some CET1 Deductions

Calendar Year % of the Deductions from CET1 capital

2015 40%

2016 60%

2017 80%

2018 and thereafter 100%

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• Deductions and adjustments including items related to deferred taxes and mortgage servicing rights phase in through 2018

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Common Equity Tier 1 (CET1) Capital Ratio

• Items to consider

– Opt-out election for Accumulated Other Comprehensive Income (AOCI)

◊ One-time election made on March 31, 2015 with the call report filing for community banks and the FR Y-9C (if applicable).

◊ Note: FR Y-9SP not applicable since consolidated capital ratios will not apply to the bank holding companies under $500M.

– Calculate and understand CET1 components and thresholds during 2014 before new rules take effect in 2015

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Prompt Corrective Action

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Prompt Corrective Action (PCA)

Adequately Capitalized Well Capitalized

2013 and 2014 Starting in 2015 2013 and 2014 Starting in 2015

Total risk-based capital

8.0% 8.0% 10.0% 10.0%

Tier 1 risk-based capital

4.0% 6.0% 6.0% 8.0%

Common equity tier 1 risk-based capital

N/A 4.5% N/A 6.5%

Tier 1 leverage capital

4.0% 4.0% 5.0% 5.0%

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Prompt Corrective Action • Items to consider

– Higher capital requirements

◊ Banks will be required to hold higher quality of capital with greater emphasis on tangible common equity

– Must meet the FDIC’s PCA capital ratios beginning January 1, 2015

◊ No phase in of PCA requirements

– Most banks are expected to remain well capitalized under the new PCA requirements

– Download and run the FDIC capital estimation tool prior to year end to estimate the change in your capital ratios under the new rules

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Capital Conservation Buffer

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Capital Conservation Buffer

• Dividends and discretionary bonuses are limited if banks fails to maintain a buffer above the minimum required capital ratios (adequately capitalized level under PCA)

• Buffer limits the payout ratio for dividends and bonuses based on a percentage of eligible retained income

– Regulators have released statement indicating that S Corporation banks that don’t meet the required capital conservation buffer will be reviewed on a case-by-case basis and will likely be able to continue to pay tax dividend distributions

• Buffer phases in over the next 5 years

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Capital Conservation Buffer 2015 2016 2017 2018 2019

Phase-in Requirement N/A 0.625% 1.25% 1.875% 2.5%

Total risk-based capital with buffer

N/A 8.625% 9.25% 9.875% 10.5%

Tier 1 risk-based capital with buffer

N/A 6.625% 7.25% 7.875% 8.5%

Common equity tier 1 risk-based with buffer

4.5% 5.125% 5.75% 6.375% 7.0%

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Maximum Payout Ratio

30

* Eligible Retained Income: The most recent 4 quarters of net income preceding the current quarter, net of any capital distributions, and certain discretionary bonus payments

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Capital Conservation Buffer • Items to Consider

– Banks will look for ways to avoid limitations on capital distributions and restrictions

◊ Potentially choosing to hold substantial excess capital over well capitalized levels

◊ Capital conservation buffer limit essentially becomes the new minimum capital ratios

– Payout ratio is based on a percentage of four rolling quarters of net income

◊ A bad quarter or year could further limit payouts if conservation buffer isn’t met

◊ Negative net income for the four quarters could mean no eligible payouts

– Possible limitations on payments of discretionary bonuses

◊ Could impact compensation structures in banks

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Risk Weighting

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Risk Weighted Asset Components

• For community banks, the majority of the risk weighting rules did not change as a result of the new regulatory capital requirements

– The new Schedule RC-R will contain additional risk weighting columns: 150%, 250%, 300%, 400%, 600%, 625%, 937.5%, 1250%

– Other than the 150% and perhaps 250% categories the others will generally not be used by community banks

• Additional information may be needed to prepare certain sections of risk weighted assets for March 31st

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Residential Mortgage Exposures

• What are residential mortgage exposures?

– New sub-category of loans on RWA table

– First or junior liens on 1-to-4 family residential real estate (not construction)

– First or junior lien multi-family residential real estate where the original and outstanding amount is $1 million or less

– Other homogenous pool multi-family residential loans

• 50% risk weighting category

– Prudently underwritten and not more than 90 days past due or on non-accrual

• 100% risk weighting category

– Other residential mortgage exposures

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High Volatility Commercial Real Estate

• HVCRE is an acquisition, development, or construction loan prior to permanent financing

– NOT: 1-to-4 family residential construction project

– NOT: Community development loan

– NOT: For the purchase of agricultural land

– NOT: Meeting certain exemption criteria

• Exemptions – must meet all to not be a HVCRE

– LTV is at or below the maximum supervisory loan-to-value

– Borrower has contributed at least 15% of “as completed” appraised value in cash

– Borrower contributed capital is contractually required to remain throughout the life of the project

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Risk Weighting for HVCREs

• New subcategory of loans on the risk weighted assets table

• All HVCREs will be risk weighted at 150% regardless of payment status

• Properly identifying HVCREs will be critical:

– Start with the pool of non-residential construction loans

– Review loan files to determine original LTVs

– Assess the initial capital contributions by borrowers

• Regulators will likely assume all non-residential construction loans are HVCRE unless proven/documented otherwise

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Risk Weighting Past Due Loans

• Loans past due more than 90 days or on nonaccrual will generally have higher risk weightings under the new rules

• Past due residential mortgages

– 100% risk weighting

• Past due HVCREs

– Stay at 150% risk weighting like the loans that aren’t past due

• All other past due loans

– 150% risk weighting

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Other Risk Weighting Considerations

• Mortgage servicing rights

– Any amount not deducted on Line 14 is risk weighted at 250%

• Deferred taxes from timing differences

– Any amount that could be realized through a carryback is risk weighted at 100%

– All other amounts not deducted on Line 15 are risk weighted at 250%

• Unused commitments

– Additional subcategories of unused commitments must be reported

– Review the instructions for further details on unused commitments less than or greater than one year that may be subject to risk weighting

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Deferred Taxes and Regulatory Capital

• Under the new regulatory capital requirements, banks need a better understanding of the components of their deferred taxes.

– General ledger account balances for deferred taxes will need to be broken out into more detailed components and reported on appropriate lines on call report

– Tax preparer will likely need to assist with helping the bank understand and categorize the components of the bank’s deferred tax assets/liabilities

• Old methodology for calculating disallowed deferred tax assets has been abandoned

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Deferred Taxes on Schedule RC-R

• Line 6 – Goodwill

– Report recorded book goodwill less any deferred tax liability associated with goodwill

• Line 7 – Other intangible assets (except MSRs)

– Report core deposit and other intangibles less any deferred tax liabilities associated

• Line 14 – Mortgage servicing rights

– For the threshold deduction, the amount used for the calculation should be mortgage servicing rights less their associated deferred tax liabilities

– Net amount is compared to the 10% and 15% thresholds to determine if a deduction to CET1 is necessary

– Deferred tax liabilities reduce overall MSRs and may help to keep them below the 10% or 15% thresholds

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Deferred Taxes on Schedule RC-R

• Line 8 – Deferred tax assets arising from net operating losses and tax credits

– Dollar for dollar reduction in capital

– These items are considered less likely to be utilized by the bank within a reasonable period

• Line 15 – Deferred tax assets and liabilities arising from temporary differences

– Sum of the remaining deferred tax items that haven’t been considered on the previous lines

– If these items result in a net deferred tax asset, compare to the 10% and 15% thresholds to determine if a deduction is necessary

– Net deferred tax asset can be reduced by any amount that could be realized from a net operating loss carryback

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Carryback Potential and Risk Weighting

• Bank is allowed to look back and see if any of the deductions/losses associated with a hypothetical reversal of the timing differences would result in a tax refund for the bank

– Generally federal tax losses can be carried back two tax years. Often state losses can not be carried back

• If the bank would receive a tax refund on the carryback, then the carryback amount can be used to reduce net deferred tax assets in Line 15.

– The refund portion is also risk weighted 100% for RWA

– All remaining timing differences not deducted on line 15 are risk weighted 250%

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Next Steps

• Become familiar with the revised call report schedules and instructions

• Visit regulatory websites for further information

• Run the FDIC’s capital estimation tool

• Identify any high volatility commercial real estate

• Discuss your deferred tax components with your tax preparer

• Consider the impact of higher required capital ratios and the capital conservation buffer on your institution

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linkedin.com/company/ cliftonlarsonallen

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Amanda C. Garnett, CPA Manager – Financial Institutions [email protected] 309-495-8842

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schedule rc-r: risk based capital - learn.claconnect.com

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