Consideration for Mutual Bank Comment Letters

Transcription

1 Consideration for Mutual Bank Comment Letters I. Opening Thoughts a. Thank the agencies for their outreach efforts and the calculator b. Note appreciation for efforts to work with mutuals to ensure that the supervisory process for mutuals works well. Comment on the historical stability of mutuals in their communities. II. III. Introduction and Overview of mutuals: a. Each banker should present an introduction of his or her bank, its charter (particularly its age and stability) and one or two community activities (that would be impacted by Basel III) Issues to Consider in Including in Your Letter (based on applicability to your institution) a. Unrealized gains and losses flowing through capital b. Equity treatment c. Pension issue d. Mortgage treatment e. Small Savings and Loan Holding Companies f. Past due exposure treatment Note: When describing these issues, please tell your story and, where possible, the impact on customers and your local communities. Also, where appropriate, please try to weave in the following general themes. i. Inability to raise capital in the market (retained earnings only) ii. Reduced lending capacity iii. How the rules would perversely factor into business decisions iv. What would the impact be on your customers and community v. How the community outreach and charitable activities of mutuals will be harmed or eliminated by Basel III vi. Costs - the proposed Basel requirements would be costly to implement and maintain (people, new requirements, retooling systems), and would generate little or no improvement in safety and soundness. vii. Mutuals are not high growth, high risk institutions prone to failure they are conservatively run and their statistics bear that fact out. IV. Goals of the Letter There are so many unintended consequences to the proposal that the agencies need to withdraw the proposed rule and start over. There is no amount of tweaking that will make this proposal work for mutual or community banks. V. Thank you. 1

2 Issue Descriptions- These descriptions are designed to help you develop your own thoughts. Remember, tell your story: Unrealized Gains and Losses: Under the proposed rule, unrealized gains and losses on available for sale securities will flow through to regulatory capital. Unrealized gains and losses occur in an available for sale portfolio primarily as a result of movements in interest rates. This change would bring interest rate risk into the regulatory capital standards and greatly increase the volatility of banks capital ratios. Mutual banks could execute four strategies to address the majority of the capital volatility problem. However, none of these methods are desirable. 1. Banks could hold substantially higher capital levels to absorb the volatility. This approach would: a. Create a volatility buffer above the new minimum requirements and capital conservation buffers also proposed. b. Further restrict banks ability to lend. c. Mutuals will be at a competitive disadvantage b/c they will potentially take longer to get to and maintain the higher capital ratios and buffer (i.e. mutuals are not able to react as quickly to volatility) 2. Sell long term securities and buy short-term securities, imbalancing a prudent balance sheet. a. The resulting shift in the duration of the investment portfolio will shift the bank s interest rate risk position from properly balanced to significantly imbalanced. Since all banks would have the same type of structural imbalance, this interest rate bet would go bad at the same time for all banks across the system. b. Such an imbalanced position is not prudent risk management. c. The lower yielding short term securities would also impact earnings making it more difficult for some banks to meet the Basel standards. 3. Sell fixed rate bonds and enter into derivative contracts with large investment banks to fix the interest rate risk imbalance. This would also have several undesirable side effects: a. Most mutual banks would have little or no prior experience with derivatives which would exacerbate the risk issues. b. The amount of financial system interconnectedness that would result from such a large volume of new derivative transactions would be considerable and represent a very large increase in systemic risk. c. The lower yielding short term securities and higher costs related to entering into the derivative contracts would also impact earnings making it more difficult for some banks to meet the Basel standards. 2

3 4. Mutuals may be able to shift a limited number of available for sale securities to held-tomaturity (HTM). However, the number of securities moved may be very small and locking them into HTM will interfere with sound liquidity management and regulatory requirements. a. The use of held-to-maturity accounting treatment for investment securities cannot be counted on as an effective durable solution given both the FASB s deliberations on its elimination over the past two years, and the fact that use of HTM effectively disallows active management of interest rate risk positions. b. Shifting assets to HTM limits interferes with a bank s liquidity management because it will limit a bank s ability to sell the assets in time of liquidity stress. c. Banks are facing a competing pressure from the regulators to hold a stock pile of highly liquid assets in ASF. Equity Treatment: Some mutual banks are subject to grandfathered state rules that allow them to hold equity exposures. As a result, the proposed equity treatment disproportionately impacts mutual banks. This impact comes in two forms: First, similar to traditional debt securities, unrealized gains and losses would be allowed to flow through capital Second, the significant increase in risk weighted assets (300% or 400 % depending on if the equity is publically traded). Profits from the grandfathered securities often are used to fund charitable activities. As a result, the regulators should examine the impact of the proposed equity treatment on certain mutual banks. Note: This aspect of the letter should be highly personalized. Please be willing to discuss how and why certain mutual banks are able to hold equity exposures. Please indicate what type of equities you hold, what percentage to equities make up your balance sheet, and how you manage this portfolio. The OCC in particular does not permit banks to hold most equity exposures so we may need to convince staff that just because it is an equity doesn t mean it is bad. If you have any loss data that indicates a 300% risk weight is not necessary it may be worth raising. Pension Issue: Mutuals do not have stock or stock options to offer their employees and as a result, many have defined benefit plans that suffer from point-in-time valuation that adds further volatility to their balance sheets. The pension plans allow mutual to compete in the 3

4 market place for talented employees. Eliminating or exacerbating the balance sheet impact through the Basel III proposal harms employees and further limits the ability of mutuals to attract and retain their employees. Mortgage Treatment: The proposal assigns risk weights to residential mortgages based on (1) whether the mortgage is a traditional category 1 mortgage or a riskier category 2 mortgage; and (2) the loan-to-value (LTV) ratio of the mortgage. This treatment is problematic for many reasons including: 1. Many mutual banks may not have the necessary data to categorize and risk weight their mortgages. 2. Even if a mutual bank does have the data, it is not likely in systems and getting the necessary data may require pulling loan files. 3. The risk weights on 2 nd mortgages, which typically fall within category 2, are extremely punitive. 4. Second mortgages will taint the first providing creating a substantially higher risk weight on both the first and second. This will be a major disincentive to secure loans. 5. PMI is not recognized in the proposed treatment even though risk is transferred. Note: Regulators will likely ask banks how they should distinguish between high credit quality PMI providers and low credit quality PMI providers. 6. Given the substantial increase in capital that would be required for such existing category 2 mortgages, which may constitute a substantial amount of assets on an institution s balance sheet, the retroactive impact of the proposed treatment would be especially harsh. Given that the Basel III NPR is already substantially increasing required minimum capital, the need for retroactive application of the new standards is significantly attenuated. Further, mortgage loans on the books today were not priced based on the new rules and higher capital requirements. 7. The proposal does not take into account future reform of the mortgage market (GSE, QRM, QM, risk retention, etc.). Given the above, we feel the mortgage treatment should be fundamentally rethought and whatever changes come, existing mortgages should be grandfathered. Small Savings and Loan Holding Companies and Mutual Holding Companies: Under the proposal, all savings and loan and mutual holding companies, regardless of size, are required to comply with Basel III. The Federal Reserve has a long standing policy statement excluding bank holding companies under $500 million from the capital rules. This policy exception was codified in Section 171 of Dodd Frank. However, the statute did not make a 4

5 similar exception for savings and loan and mutual holding companies under $500 million. The Basel III proposal needs to include a similar exemption so that these institutions are not subject to the full panoply of capital rules including the common equity tier one ratio and the conservation buffer. Note: We may hear that the banking agencies current position is that Section 171 of the Dodd Frank Act does not allow them to make exceptions for small savings and loan holding companies. Given the authority DFA grants to the Fed, there is plenty of authority for the Fed to extend the exclusion to SLHCs and MHCs under $500 million and we should first stress the need to extend the exclusion (and not let the agencies punt when they clearly have not limited themselves to the statute in other regulatory efforts). Past Due Exposures: The Standardized Approach NPR proposes to assign a 150 percent risk weight to non-mortgage exposures that are 90 days or more past due or on nonaccrual. In addition, the proposal categorizes all past due mortgage loans as category 2 mortgages (meaning they could get as high as 200% risk weight). These treatments are fundamentally inappropriate because it ignores: (1) the independent requirement to increase loss reserves for past due loans; and (2) the required 100 percent deduction from capital for certain of those increased loss reserves. Banks increase loan loss reserves when loans become delinquent, independent of riskbased capital standards, and external auditors and agency examiners carefully review such increased provisioning to ensure that loan loss reserves are adequate. Such increases in reserves effectively increase the loss-absorption capacity of the bank in the same way as increased capital. Thus, requiring higher risk weights for past due loans, which at the margin would result in higher capital for such loans, effectively results in a kind of double counting of the increased loss absorption capacity already resulting from provisions to the loan loss reserve for the very same loans. Moreover, loan loss reserves exceeding 1.25 percent of standardized assets are separately required to be deducted from Tier II capital. In such circumstances, requiring higher risk weights for delinquent loans while at the same time deducting from capital the provisions associated with such loans would result in an even greater degree of double counting. In this context, further increasing the risk weight for past due exposuresin addition to increasing associated reserves and the potential capital deduction for such reserveseffectively double-counts the risk of default for delinquent loans. As a result, the risk weight for such loans should not be increased to 150 percent. 5