The amount of required regulatory capital on specified assets naturally has a significant impact on a bank's operations.  There are times when these requirements either have accounting impacts or accounting rules impact the required capital.  ABA supports regulatory requirements that merely make sense in the context of the current business environment. 

Current Issues

Consolidation of Assets and Liabilities in Special Purpose Entities | Limitation on Trust Preferred Securities | Tier 1 treatment to CPP Investments | Treatment of Downgraded Debt Securities

Consolidation of Assets and Liabilities in Special Purpose Entities
The FASB issued rules in June 2009 that will require many loans securitized through a special purpose entity to be recorded back on the balance sheets of security sponsors (FAS 166 and 167).  In anticipation of this, ABA has been in contact with banking regulators over the past year, advising the agencies to coordinate release of the FASB pronouncements with agency guidance as to how such changes will be treated for regulatory capital purposes.  The ABA recommended changes to the regulators in order to more accurately reflect the risk of the assets that are expected to now be reflected on certain bank balance sheets.

Among the recommendations:

• Apply a "look through" of reported loans that carry a third-party guarantee (because they reside in a security), but, because a transaction failed "sale accounting", are still reported as loans. Among other circumstances, certain guaranteed mortgage securitizations are expected to no longer receive sales accounting treatment.  These loans, however, should apply a risk weighting equal to that of a guaranteed security.
  
•  Link loans that are in bankruptcy remote trusts to the corresponding liabilities and disregard them from capital calculations, since they are not available to creditors and also present a very different risk profile to the sponsoring bank than if actually held as a loan. 
• Provide a three year transition period for any changes made, considering the significant effects these amendments can have on regulatory capital, with no new regulatory requirements in the first year of transition. 

ABA expects the FASB amendments, which affect when entities may record sales of financial assets, as well as when they must consolidate special purpose entities, to be issued by the end of June.  Read the letter.

Limitation on Trust Preferred Securities

The Federal Reserve Board has delayed the effective date of a rule to limit the amount of Trust Preferred Securities within Tier 1 Capital for regulatory capital purposes.  The limit of 25% of core capital elements, originally to be effective after March 31, 2007, will now go into effect after March 31, 2011.

Federal Reserve Gives Tier 1 Treatment to CPP Investments

The Federal Reserve Board recently announced a final rule that allows bank holding companies to include in their Tier 1 capital without restriction senior perpetual preferred stock issued under the Troubled Asset Relief Program.  The rule finalizes the interim final rule adopted in October.

The Fed also announced adoption of an interim final rule to allow bank holding companies that are S-Corporations or organized in mutual form to include in Tier 1 capital all subordinated debt issued to Treasury under TARP, provided that the subordinated debt will count toward the limit on the amount of other restricted core capital elements includable in Tier 1 capital.  ABA had urged regulators to also allow banks and thrifts that are not holding companies to recognize the funds as Tier 1 capital.  Read the rule.

Downgraded Securities

ABA has released a White Paper, concluding that the treatment by the federal banking agencies of banks' investments in downgraded debt securities do not reflect the underlying economic fundamentals of these investments and has resulted in unwarranted lower capital ratios and poorer examination ratings that may cause serious and unnecessary capital impairment to a number of banks.  The majority of banks that are being affected by this unduly harsh treatment are community banks with less than $500 million in assets.  The regulatory treatment of community banks is much more severe than that being imposed on larger banks, given the ability of larger banks to utilize internal models to calculate more accurately their regulatory capital charges.

Moreover, we believe that the capital and asset classification treatment of these securities by the federal banking agencies is inconsistent with their own guidance and disrupts the guidance issued by FASB on the proper accounting for these securities.  As a result of this inconsistent treatment, we believe that the illiquid market for MBSs and other debt securities will be protracted, making economic recovery more difficult and protracted.

As stated above, we fully support improvements in the level and quality of bank capital, but we strongly believe that these rules are unduly punitive in that they do not reflect the true risk of these securities to banks and create competitive distortions between banks of different sizes and levels of complexity.  The rules should be applied with a more consistent end result and in a manner that is truly risk-based and reflective of the true underlying risk of the investment.

Questions? Please contact Michael Gullette, VP- Accounting and Financial Management, for more information.