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CLAconnect.com

Basel III Capital Ratios Impact on Community Banks

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• A national CPA and consulting firm • Service areas include assurance,

tax, consulting, and outsourcing • 3,600 employees • Offices coast to coast • Financial Institutions group

serves more than 750 bank clients across the country

About CliftonLarsonAllen

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Speaker Introduction

Scott H. Lively Scott is a principal in the financial institutions practice and has more than 22 years of experience providing audit, tax, and consulting services. He works with clients predominately throughout Missouri, Illinois, Indiana, Kentucky, Arkansas and Tennessee ranging in size from $20 million to several billion in assets.

His duties also include principal-in-charge of the St. Louis Financial Institutions practice, member of the firm’s National Financial Institutions committee and Credit Risk Review committee.

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Overview

• Common Equity Tier 1 Capital (CET1) ratio created

• Prompt Corrective Action (PCA) thresholds revised

• Capital Conservation Buffer created

• Risk weights for various assets changed

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Common Equity Tier 1 (CET1) Capital Ratio

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Common Equity Tier 1 (CET1) Capital Ratio

• Definition Common stock plus related surplus net of treasury stock plus

retained earnings +/- accumulated other comprehensive income (AOCI) + qualifying CET1 minority interest +/- deductions

◊ Goodwill ◊ Other intangibles (other than goodwill and mortgage servicing

rights) ◊ Deferred tax assets that arise from net operating loss and tax

credit carry forwards, net of any valuation allowances

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Common Equity Tier 1 (CET1) Capital Ratio +/- threshold-based deductions (>10% individually or >15%

aggregate of CET1 Capital) ◊ Non-significant investments in the capital of unconsolidated

financial institutions that exceed 10% threshold ◊ Mortgage servicing rights (MSAs) that exceed 10% threshold ◊ Net deferred tax assets, net of related valuation allowances that

exceed 10% threshold (elimination of 12 month recognition period for DTA disallowance)

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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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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 opt-out 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 (PCA)

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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 (PCA)

• 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 prompt corrective action (PCA) capital ratios beginning January 1, 2015

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Capital Conservation Buffer

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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

Capital Conservation Buffer (based on RWA)

Greater than 2.5% No limitation

Less than or equal to 2.5% and greater than 1.875% 60%

Less than or equal to 1.875% and greater than 1.25% 40%

Less than or equal to 1.25% and greater than 0.625% 20%

Less than or equal to 0.625% 0%

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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

– S-Corp Banks will need to factor any restrictions on distributions to shareholders for tax payments into their capital planning

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Risk Weighting

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Risk Weights for Various Assets Changed

• What Changed in Risk Weights – Past-due loans to 150% for portion that is not guaranteed or

secured – High volatility commercial real estate (HVCRE) exposures to

150%. ◊ HVCRE means a credit facility that finances or has financed the

acquisition, development, or construction (ADC) of real property unless the facility finances:

• 1-4 family residential properties , community development, farmland • CRE projects with:

– LTV ratio less than or equal to maximum supervisory LTV ratio – Borrower contributes at least 15% of appraised “as completed” value in

cash or marketable assets – Borrower contributed capital is contractually required to remain

throughout the project life

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Risk Weights for Various Assets Changed

• What did NOT Change in Risk Weights – 1-4 family residential mortgage risk weighting remains the same with

both 50% and 100% risk weighting – No change for balloon and interest only mortgages – Owner-occupied CRE loans – C&I loans – Consumer and credit card loans – BOLI – general account BOLI will continue to be risk weighted at 100% – Federal Reserve Bank stock still 0% risk weight – Federal Home Loan Bank stock still 20% risk weight

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Next Steps

• Estimation tool available from regulators • Become familiar with Call Report Schedules and

Instructions • Visit regulatory websites for updates

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• John Wayne Quote: – If everything isn’t black and white, I say, “Why the hell

not?”

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CLAconnect.com

twitter.com/ CLAconnect

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linkedin.com/company/ cliftonlarsonallen

Scott H. Lively Principal scott.lively@CLAconnect.com 314-925-4370

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