The Community Bank Leverage Ratio: Questions, Answers and Additional Considerations

January 22, 2020 | Article

What is the Community Bank Leverage Ratio (CBLR)?
On September 17, 2019, the banking regulators issued the “Regulatory Capital Rule: Capital Simplification for Qualifying Community Banking Organizations.” This new capital rule is designed to reduce the burden of reporting risk-based capital ratios by providing a simple measure for capital adequacy. The CBLR is effective on January 1, 2020, and Qualified Community Banking Organizations may opt in with an election on the March 31, 2020, call report.

How does an institution qualify for the CBLR Framework?
In order to be considered a Qualified Community Banking Organization for the new capital rule, banking institutions must meet the following criteria:

  • Leverage ratio greater than 9%
  • Consolidated assets less than $10 billion
  • Total off-balance sheet exposures less than 25% of total consolidated assets based on the most recent calendar quarter, including the following more common exposures:
    • The unused portions of commitments (except for unconditionally cancellable commitments)
    • Sold credit protection in the form of guarantees and credit derivatives
    • Credit-enhancements (e.g. Federal Home Loan Bank MPF program)
    • Letters of credit (e.g. public funds pledging)
    • Forward agreements that are not derivative contracts
    • Securities lending and borrowing transactions (e.g. RC-L 6.a and 6.b)
    • Other, less common, exposures listed in the final rule
  • Trading assets and liabilities of 5% or less of total consolidated assets
  • Not an advanced approaches banking organization

A qualified community banking organization may opt in or out of the CBLR each time it completes the call report by making the appropriate election and thereby completing the associated reporting requirements corresponding with their election.

What if our institution adopts the CBLR but subsequently fails to meet the criteria above?
The final rule allows for a “grace period” for qualifying organizations that fail to satisfy one or more of the qualifying criteria listed above but continue to maintain a leverage ratio of 8% or higher. This grace period provides up to two quarters during which the qualified organization can continue to utilize the CBLR framework and be considered “well capitalized” for regulatory reporting purposes. After two quarters, a qualifying organization will be required to complete the relevant risk-based capital reporting framework if the organization (1) is unable to restore compliance with all qualifying criteria (including reporting a leverage ratio in excess of 9%) or (2) has a leverage ratio of 8% or less.

It should be noted that the grace period is not applicable to qualifying organizations that fail to meet qualifying criteria due to a merger or acquisition.

Should our institution adopt the CBLR framework?
As with many decisions, it depends. The decision is largely dependent upon the individual institution, strategic and capital plans, staffing over the call report process and overall growth objectives. As your institution approaches the March 31, 2020, call report filing date, some of the following topics would be worthy of consideration among board and senior management teams.

  1. Current Leverage Ratio
    The institution’s current leverage ratio is an obvious starting point for discussion. If the current leverage ratio is in excess of 9% and has been for a long time, the CBLR framework may be an easy decision. However, be sure to take a long-term view on capital needs. Consider historical and prospective asset growth rates, dividends and acquisitions. Don’t forget about credit quality and its potential impact to capital during a prolonged downturn as well.

     

  2. Time Savings and Burden Relief
    The main objective of the CBLR framework was to reduce the burden of calculating and completing risk-based capital ratios. The framework will certainly meet this objective. Every institution has a different process for completing the call report, including the individuals involved and their levels within the organization. The true time savings, efficiency and ability to reallocate time and talent will vary greatly from one bank to the next.

     

  3. Succession Planning and Knowledge Transfer
    If an institution adopts the CBLR, it will no longer have to calculate and complete schedule RC-R Part II. While this is the intended relief discussed above, the bank should consider the process for retaining their existing reporting knowledge. Additionally, potentially new risk-based capital rule changes or the impact of changes in product offerings may create difficulty in completing RC-R Part II in the future (if necessary).

     

  4. Mergers and Acquisitions
    If your institution is actively engaged or seeking M&A activity, consider your capital needs in those scenarios. The final rule explicitly excludes mergers and acquisitions from the two-quarter grace period. As such, if an institution were to choose to adopt and maintain the CBLR framework during a merger or acquisition, they would, in effect, be imposing a limitation on accessing existing capital to help facilitate such a transaction.

Fortunately, the final rule allows banks to opt in and out of the CBLR framework with each call report filed, so the initial decision isn’t final. With that said, there is still time for strategic discussions around the topics above as well as any institution-specific considerations that may be relevant to help you make a well-informed decision by March 31.

It is important to take these necessary steps noted above, and the time to start is right now. Please contact your Eide Bailly professional if you need assistance with the new CBLR framework.

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