ABA Mutual Institutions Council Capital Issues for Mutuals Richard A. Schaberg Richard L. Quad October 14, 2012
Contents I. Sources of Capital for Mutuals II. III. Regulatory Issues with Preferred Stock Issuance by Mutuals Market Considerations for Mutual Capital IV. Next Steps V. Overview of Mutual Depositories 2
I. Sources of Capital for Mutuals Retained Earnings The primary source of capital creation for mutuals threatened by: Slow growth Margin compression Intense competition Asset quality challenges Increasing expenses of compliance and regulation Requires careful, regular capital planning 3
I. Sources of Capital for Mutuals Balance Sheet Management to Augment / Maintain Capital Ratios Limits on growth Asset shrinkage, as necessary Maximize fee-generating loans (SBA, mortgage, warehouse) Seek higher yielding loans such as niche products (auto, mobile home, boats, equipment leasing) Non-interest income Branch cost benefit analysis Overlap/redundancy Sale v. retention impact Sale/leaseback options 4
I. Sources of Capital for Mutuals Pledged deposits & nonwithdrawable accounts OTS permitted in Tier 1 capital if No fixed maturity date No withdrawal at accountholder option No interest carried over to subsequent periods FDIC informal resistance Subordinated debentures Rarely used Not counted as Tier 1 capital and limited use as Tier 2 capital 5
I. Sources of Capital for Mutuals Mutual Capital Certificates Created by statute in 1980 for federal mutual thrifts Meant by Congress to be an equity investment analogous to capital stock that could be used as part of a strong capital base Some states also provide option for state mutual thrifts (e.g., California, Virginia & North Carolina) Issued and sold by thrifts directly or through underwriters OCC carried over regulation (12 C.F.R. 163.74) Includable as tier 2/supplemental capital Issuance does not constitute change in control Subordinate to all savings accounts, savings certificates and debt obligations Not eligible for use as collateral for any loan made by issuing thrift Constitutes a claim in liquidation on general reserve, surplus and undivided profits remaining after profit 6
I. Sources of Capital for Mutuals Mutual Capital Certificates OCC carried over regulation (continued) Entitled to payment of dividends May have a fixed or variable dividend rate, participating or cumulative Not redeemable at option of holder Not redeemable by association except Where dollar weighted average term of each issue is 7 years or more In event of merger, consolidation or reorganization Where funds for redemption are raised by issuance of replacement MCCs In conjunction with issuance of capital stock Preemptive rights Voting rights limited to those typically allowed to preferred stock Not an obligation of the association Not convertible Rarely Used 7
I. Sources of Capital for Mutuals No-Stock MHC / TPS Previously counted as tier 1 capital Pooled transactions no longer available Proposed capital rules require institutions with less than $15 billion in consolidated assets as of December 31, 2009, to exclude from tier 1 capital hybrid instruments, such as TPS, within a 10-year conformance period 8
I. Sources of Capital for Mutuals TARP Subordinated debentures for mutuals Tier 2 capital Program developed late for mutuals Program no longer open No mutual participated 9
I. Sources of Capital for Mutuals SBLF Unsecured subordinated debentures for mutuals Treated as Tier 2 capital Program no longer open Mutual participation 1 mutual bank participated 2 intermediate holding companies in MHC structure 10
I. Sources of Capital for Mutuals Preferred Stock Certain states permit issuance by mutuals (e.g., Massachusetts) Not an option for federal savings associations Features Noncumulative Perpetual Nonvoting Subordinate to depository liquidation accounts Treated as debt in a mutual-to-stock conversion FDIC has historically been reluctant to approve 11
II. Regulatory Issues with Preferred Stock Issuance by Mutuals NPR Basel III Tightens definition of capital Regulatory Capital Components Common equity tier 1 capital Additional tier 1 capital Tier 2 capital Common equity tier 1 capital (CET1) Common equity tier 1 capital instruments and related surplus (net of treasury stock) voting should be dominant form of CET1 capital Retained earnings Accumulated other comprehensive income Common equity tier 1 minority interest 12
II. Regulatory Issues with Preferred Stock Issuance by Mutuals NPR Basel III (continued) Discusses tier 1 Capital for mutuals to the extent meet all criteria Retained Earnings Nonwithdrawable accounts Pledged deposits Mutual capital certificates 13
III. Market Considerations for Mutual Capital What considerations are necessary to sell capital for mutuals? Structure depends on need for CET1 or additional Tier 1 Coupon / dividend Financial performance / asset quality Size Liquidity Who are likely buyers? Buyers of conversions (understand mutuality) Fixed income / yield buyers Difficult for non-accredited retail due to lack of liquidity and transparency Customers (issues to resolve) 14
IV. Next Steps Develop alternative investment instruments allowable as CET1 or additional tier 1 capital? U.K. core capital deferred shares approved by FSA as CET1 Permanent No maturity date No stated call date Discretionary interest payment linked to earnings Lowest level in liquidation Listed on London Stock Exchange 15
V. Overview of Mutual Depositories Mutuals by Geography West, 13 Southwest, 26 Southeast, 51 Northeast, 171 Midwest, 182 Mid Atlantic, 118 Source: SNL Financial; as of most recently reported quarter 16
V. Overview of Mutual Depositories Mutuals Assets by Geography Southeast, 11,703 West, 5,711 Southwest, 4,793 Midwest, 45,147 Northeast, 106,655 Mid Atlantic, 53,835 Dollars in thousands Source: SNL Financial; as of most recently reported quarter 17
V. Overview of Mutual Depositories Mutuals by Size > $3b, 8 $1-3 b, 31 < $100m, 188 $500m -$1b, 78 $250m -$500m, 115 $100m -$250m, 141 Source: SNL Financial; as of most recently reported quarter 18
V. Overview of Mutual Depositories Assets by Size Category Mutuals less than $250 million in assets account for 15% of aggregate size Mutuals greater than $1 billion account for 42% of aggregate size $100m -$250m, 23,434 < $100m, 10,605 > $3b, 49,473 $250m -$500m, 40,849 $1-3 b, 47,127 $500m -$1b, 56,357 Dollars in thousands Source: SNL Financial; as of most recently reported quarter 19
V. Overview of Mutual Depositories Total Loan and Deposit Growth 180,000 170,000 160,000 150,000 140,000 130,000 120,000 110,000 100,000 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Mar-12 Jun-12 Loans Deposits Dollars in thousands Source: SNL Financial CAGR of 4.1% in total loans and 7.1% in total deposits 20
V. Overview of Mutual Depositories Return on Average Assets Return on Average Equity 0.50 0.40 0.39 0.30 0.31 0.42 0.43 0.47 5.00 4.00 3.01 3.49 3.46 3.85 0.30 3.00 2.35 2.33 0.20 2.00 0.10 1.00 0.00 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 MRQ 0.00 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 MRQ Net Interest Margin Efficiency Ratio 3.50 3.30 3.10 2.90 2.70 2.92 3.07 3.19 3.31 3.31 3.26 82 80 78 76 74 72 80.76 79.87 79.94 75.63 76.79 76.18 2.50 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 MRQ 70 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 MRQ Source: SNL Financial; note medians are not size weighted 21
V. Overview of Mutual Depositories Leverage Ratio and Tangible Equity 12.50 12.07 12.14 11.50 11.53 11.41 11.16 11.10 11.13 10.99 11.20 11.28 11.25 11.33 10.50 9.50 8.50 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 MRQ Leverage ratio Tangible Equity / Tangible Assets Source: SNL Financial 22
V. Overview of Mutual Depositories Tangible Equity / Tangible Assets by Category 245 250 200 150 100 80 77 54 55 50 15 35 0 Source: SNL Financial Below 7% 7-8% 8-9% 9-10% 10-11% 11-12% Greater than 12% 23
V. Overview of Mutual Depositories Estimate of CET1 (using tangible equity / RWA) 29.86 30.00 25.96 25.00 21.08 18.33 20.00 15.84 13.77 15.00 10.00 Fully phased in Basel III requirement = 7% 5.00 0.00 First Quartile Median Third Quartile Estimate CET1 Increase RW Assets 15% Source: SNL Financial; Even when stressing risk weighted assets by 15% to account for the increased weightings of Basel III, the median estimated CET1 using rough assumptions is well in excess of fully phased in requirements 24
V. Overview of Mutual Depositories Tier 1 Risk Based Ratio for Mutuals 29.41 30.00 25.57 25.00 20.50 20.00 15.50 17.82 15.00 13.47 10.00 Fully phased in Basel III requirement = 8.5% 5.00 0.00 First Quartile Median Third Quartile Estimate Tier 1 Risk Based Ratio Increase RW Assets 15% Source: SNL Financial; Tier 1 risk based ratios, even when stressing risk weighted assets an additional 15% to account for higher weightings under Basel III, are also well in excess of newly established and higher benchmarks 25
V. Overview of Mutual Depositories Total Risk Based Capital Ratio for Mutuals 35.00 30.28 30.00 26.33 25.00 20.00 16.75 14.56 21.58 18.77 15.00 Fully phased in Basel III requirement = 10.5% 10.00 5.00 0.00 First Quartile Median Third Quartile Estimate Total Risk Based Ratio Increase RW Assets 15% Source: SNL Financial; Total risk based capital, even when risk weighted assets are increased 15% to account for increased weightings in Basel III, are on average well within newly established guidelines 26
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