The FDIC, OCC and Federal Reserve have issued their proposal for implementing the Community Bank Leverage Ratio under Section 201 of the Economic Growth, Regulatory Relief and Consumer Protection Act (EGRRCP Act) enacted in May of 2018. This proposal was made public in a November 21, 2018 press release and is expected to appear in the Federal Register soon with comments due by April 9, 2019 (Link to NPR).

Under the proposal, a community banking organization would be eligible to elect the community bank leverage ratio framework if:

• Less than $10 billion in total consolidated assets

• Total off-balance sheet exposures < 25% of total assets

• Total trading assets and liabilities < 5% of total assets

• Limited amounts of certain assets such as deferred tax assets, and

• Community Bank Leverage Ratio (CBLR) greater than 9 percent.

A qualifying community banking organization that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements - this is the regulatory relief. Such a community banking organization would be considered to have met the capital ratio requirements to be well capitalized for the agencies’ prompt corrective action rules provided it has a CBLR greater than 9 percent.

Calculation of the CBLR:

CBLR = Tangible Equity Capital divided by Average Total Consolidated Assets

Key considerations by federal banking regulators in designing CBLR framework:

1. CBLR framework is intended to be available to a meaningful number of well capitalized banking organizations with less than $10 billion in total consolidated assets.

2. CBLR should be calibrated to not reduce the amount of capital currently held by qualifying community banking organizations.

3. Federal bank regulatory agencies intend for banking organizations with higher risk profiles to remain subject to the generally applicable capital requirements to ensure that such banking organizations hold capital commensurate with the risk of their exposures and activities.

4. Federal bank regulatory agencies would maintain the supervisory actions applicable under the PCA (Prompt Corrective Action) framework and other statutes and regulations based on the capital ratios and risk profile of a banking organization.

5. CBLR framework is intended to provide meaningful regulatory compliance burden relief and be relatively simple for banking organizations to implement.

The federal banking regulators chose 9.00% as the initial CBLR - selecting the mid-point in the 8.00% to 10.00% range in the EGRRCP Act. Not an unexpected starting point.

At the 9.00% CBLR, it would appear that approximately 77 percent of Community Banks (total assets < $10 billion) would meet this threshold. And 58 percent of Community Banks would exceed this threshold by at least 100 basis points.

So how does this new CBLR and the 9.00% threshold compare to current bank capital standards?

The CBLR is comparable to the Leverage Ratio under current capital regulations. And, under the Prompt Corrective Action rules, a “well capitalized” bank would need to have a 5.00% Leverage Ratio. So the initial target for CBLR of 9.00% requires Community Banks to hold 400 basis points more in capital than required under PCA. And many Community Banks significantly exceed the PCA Leverage Ratio minimum today

The CBLR can also be roughly converted into a corresponding Total Capital Ratio under the current risk-based capital standards. Depending upon the ratio of risk-weighted assets to total assets, the 9.00% CBLR translates into a range of 11% to 13% Total Capital Ratio. Again, most Community Banks hold Total Capital Ratios within or above this range.

So what should a Community Bank do?

Today many Community Banks hold capital at levels that will meet or exceed the requirements under this proposal while also exceeding the current capital regulations significantly.

However, under the CBLR proposal, a Community Bank will be committing to holding this higher level of capital.

If a Community Bank already exceeds this minimum, why not simply designate that you will operate under this new proposal?

Key questions or issues for consideration before you make this election:

1. What is the cost burden - and your benefit - of complying with the risk-based capital rules - systems, Call Report schedules, etc.?

2. Will you need any of the higher levels of capital in the future (balance sheet growth, acquisitions, returning capital to shareholders) - that is, will you utilize some of your “excess” capital?

3. How difficult will it be and what is the cost to implement operating procedures to opt back out of the CBLR framework at a later date?

While the simplicity of this approach may be beneficial, an important consideration is whether this CBLR proposal becomes a constraint on your capital management flexibility in the future.

Incorporate your assessment of the CBLR in your long range strategic and capital planning activities. And make a disciplined assessment of the trade-offs prior to making your final CBLR election.

 Analytical Comparison: While simplistic, a quick means to assess whether a Community Bank should take advantage of the CBLR election is to compare the cost burden of risk-based capital compliance to returning capital to shareholders (or another alternative is to leverage the additional CBLR capital with earning assets).

If a Community Bank were to dividend excess capital to shareholders, there would be a loss of interest income from the earning assets that are liquidated. Let’s assume that this yield = 3.50%. And let’s assume that the Community Bank can dividend up capital equal to 2% of total assets rather than committing to hold that extra capital under the CBLR proposal. For a $25 million total asset Community Bank, this results in lost income of approximately $18 thousand ($500 thousand in excess capital times opportunity cost of 3.50%). Does a $25 million Community Bank spend over $18 thousand annually in compliance of risk-based capital reporting? As the size of the Community Bank increases, this opportunity cost rises. For a $500 million total asset Community Bank, the opportunity cost increases to $350 thousand. Does a Community Bank of this size spend that much on risk-based capital compliance and reporting?