How Does Basel III Impact You? Presented by: Michael Trickey, CPA

Managing Director

Berkshire Advisors, LLC

553 Capital Drive, Lake Zurich, IL 60047 847-540-6554 www.BGLP.com

“You never want a serious crisis to go to waste.”

“And what I mean by that, it’s an opportunity to do things you think you could not do before”

-- Rahm Emanuel

“All great changes are preceded by chaos.”

-- Deepak Chopra

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Agenda

• Overview of Basel III

• U.S. implementation of Basel III

• Details of Basel III

• Interaction of Basel III with Dodd-Frank Act

• Implications of Basel III changes

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OVERVIEW OF BASEL III

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What is Basel III? Basel III is the third installment of the Basel Accords (meetings held in Basel Switzerland), developed by the Basel Committee of Banking Supervisors (BCBS) Includes regulators from 26 countries, including U.S. Federal Reserve, FDIC and OCC participate on BCBS • Developed in response to deficiencies in financial regulation revealed in late-

2000s financial crisis • Purpose –

• Strengthen bank capital (better quality and risk buffers) • Decrease bank leverage (enforce minimum ratios of

regulatory capital to total on and off-balance sheet exposures)

• Increase bank liquidity positions (both short-term and longer-term)

• Improve disclosures

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Basel III – Promulgation and Adoption

• BCBS introduced Basel III in December 2010, further developed it in June 2011, and have continued to issue updates

• U.S. regulators

• Initially adopted revised capital rules in July 2013

• Ongoing updates in conjunction with BCBS updates

• Largely making refinements and introducing liquidity rules

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U.S. IMPLEMENTATION OF BASEL III

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Covered “Banking Organizations”

• US Basel III generally applies to “Banking Organizations” as follows:

• National banks

• State member banks

• State nonmember banks

• U.S. bank holding companies (BHCS) other than small BHCs

• State savings associations

• Federal savings associations

• Covered savings and loan holding companies (SLHCs)

• Any of the above that are subsidiaries of foreign banks

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Scope of Coverage Differs Among Subcategories of Covered Organizations

• U.S. Globally Systemically Important Banks (G-SIBs)

• Advanced Approaches Insured Depository Institution (IDI) Subsidiaries of G-SIBs

• U.S. Systematically Important Financial Institutions (SIFIs)

• Advanced Approaches Banking Organizations

• Market Risk Banking Organizations

• Banking Organizations - distinctions by asset size:

• >= $50 billion

• >= $15 billion

• >= $10 billion

• >= $500 million

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Definitions • G-SIBs - Top tier BHCs having > $700 billion in total

consolidated assets or > $10 Trillion in assets under custody and Advanced Approaches IDI subsidiaries of any such BHC.

• SIFIs –Banking organizations (and non-banking organizations designated by SFOC) having > $50 billion in total consolidated assets

• Advanced Approaches Banking Organizations: 1) mandatory “core” banking organizations having consolidated total assets of $250 billion or more, consolidated on-balance sheet foreign exposure of $10 billion or more, or are a subsidiary of a core bank, and 2) those that voluntarily apply the advanced internal ratings approach for credit risk and the advanced measurement approach for operational risk

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G-SIBs, Advanced Approaches and SIFIs

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Asset

Rank

Banking

Organization

3/31/2014 Total

Assets ($BIL)

3/31/2014

Custody Assets

($BIL)

Adv'd

Apprch

Banking Orgs

G-SIB

Flag

1 JPMorgan Chase $2,477 20,388$ 1 12 Bank of America $2,153 127$ 2 23 Citigroup $1,895 10,719$ 3 34 Wells Fargo $1,547 666$ 4 45 Goldman Sachs $916 -$ 5 57 Morgan Stanley $831 6$ 6 6

11 US Bank $371 990$ 712 Bank of NY Mellon $368 20,595$ 8 713 PNC $324 86$ 914 HSBC $309 24$ 1015 Capital One $291 3$ 1116 State Steet $257 20,058$ 12 818 TD Bank $237 10$ 19 BB&T $185 $ 10 20 Suntrust $180 64$ 21 American Express $151 -$ 1322 Ally Bank $148 -$ 25 Fifth Third $130 240$ 27 RBS Citizens $127 $ 5 28 Regions $118 17$ 29 BMO Harris $114 127$ 30 Santander $109 -$ 31 Union Bank $107 122$ 32 Northern Trust $104 4,319$ 1433 KeyCorp $91 42$ 34 M&T $89 62$ 35 Bank of the West $85 0$ 36 Discover $80 -$ 37 BBVA Compass $75 2$ 38 Deutsche Bank $73 37$ 39 Comerica $66 52$ 40 Huntington $61 49$ 41 Zions $56 2$

Special CategorySize Indicatiors

Non-Banks Designated as Systemically Important:

Asset

Rank

Banking

Organization

3/31/2014 Total

Assets ($BIL)

3/31/2014

Custody Assets

($BIL)

6 MetLife $891 -$

8 Prudential Financial $747 -$

9 AIG $54725$

10General Electic

Capital Corp$517

-$

Size Indicatiors

DETAILS OF BASEL III

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U.S. Roll-out Key Provisions

1. Revised Definition of Regulatory Capital 2. Capital Buffers 3. Risk-Weighted Assets 4. Leverage Ratio 5. Liquidity 6. Disclosures 7. Prompt Corrective Action (PCA) Thresholds adjusted

8. Codifies rules into a harmonized integrated regulatory framework

9. Roll-out 1. Starts 1/1/2014 for Advanced Approaches 2. Starts 1/1/2-15 for all others 3. Phase-in of some items

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Final Rule - Basel III Minimum Capital Requirements

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NewCommon Equity Tier 1:

Common Equity Tier 1:Countercyclical Buffer (if deployed)

Common Equity Tier 1:Capital Conservation Buffer

Prior

Tier 2

Tier 2Additional Tier 1

Tier 1Common Equity Tier 1

New Minimum

Transitional Period

* New Adequately Capitalized Minimums

Minimum Capital Requirements

Global Systematically Important Banks (G-

SIB) Surcharge

(core and restricted

capital elements, with

common equity as

"dominant" form)

6% Tier 1

Capital*

Advanced Approaches

Banking Organizations only

Being addressed now;

U.S.more stringent than BCBS

8% Total

Capital*

4.00%

4.00%

1% - 4.5%

0% - 2.5%

4.5%*

1.50%

Failure to maintain a buffer of

at least 2.5% results in

limitations on dividends and

executive bonuses

2.00%

2.50%

Payout Limitations Based on Size of Capital Conservation Buffer

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Maximum Payout Ratio Size of Buffer

as % of Eligible Retained Income (% of RWA)

No Limit Greater than 2.5

60 >1.875 to 2.500

40 >1.125 to 1.875

20 >0.625 to 1.250

0 <= 0.625

Calculation of Capital Ratios

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Well Capitalized

Adequately Capitalized

Risk Based Capital Ratio %

Regulatory Capital

= -----------------------------------

Risk-Weighted Assets

CET1 Capital Ratio %

CET1 Capital

= ----------------------------------- = 6.50% 4.50%

Risk-Weighted Assets

Tier 1 Capital Ratio %

Tier 1 Capital

= ----------------------------------- = 8.00% 6.00%

Risk-Weighted Assets

Total Capital Ratio %

Tier 1 + Tier 2 Capital

= ----------------------------------- = 10.00% 8.00%

Risk-Weighted Assets

Regulatory Capital • Common Stock plus surplus • Retained Earnings • AOCI • CET1 Minority Interests • Less:

• Goodwill, net of DTLs • Securitization gains • Gains (losses) on certain cash flow hedges • Insignificant investments in Financial institutions • Other CET1 deductions

• Threshold deductions , net of DTLs

• CET1 • Additional Tier 1 capital items and deductions

• Tier 1 • Tier 2 capital items and deductions

• Tier 2 • Total Regulatory capital

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Risk-Weighted Assets (RWA)

• Each Balance sheet asset amount x RWA Factor

• Each Non-balance sheet exposure x credit conversion factor x RWA factor

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Minimum Leverage Requirements

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New

Enhanced Supplementary Leverage

Buffer

New US Top Tier BHCs only

Supplementary Leverage Ratio (SLR)

Adequately Capitalized Minimum

Applies to Advance Approaches Banking

Organizations

Generally Applicable Leverage Ratio

Adequately Capitalized Minimum

Applies to all US Banking Organizations

3.00%Advanced Approaches

Banking Organizations only

4.00%

2.00%

Failure to maintain a buffer of

at least 2.0% results in

limitations on dividends and

executive bonuses

Minimum Leverage Requirements

- U.S. Top Tier BHC defined as having > $700 billion in total consolidated assets or > $10 trillion in assets under custody and any

Advanced Approaches IDI subsidiary of such BHCs

- The Supplementary Leverage Ratio includes many off-balance sheet exposures in its denominator; the Generally Applicable

Leverage Ratio does not

- The Supplementary Leverage Ratio = Tier 1 Capital / Total Leverage Exposures (incorporates off-balance sheet exposures)

- The Generally Applicable Leverage Ratio = Tier 1 Capital / Average Total Consolidated Assets

Advanced Approaches Subsidiary IDIs of

US Top Tier BHCs BufferNeed 6% SLR to be Well

Capitalized1.00%

Payout Limitations Based on Size of Leverage Buffer for Top Tier US BHCs and their Advanced

Approaches IDI Subsidiaries

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Maximum Payout Ratio Size of Buffer

as % of Eligible Retained Income (% of RWA)

No Limit Greater than 2.0

60 >1.500 to 2.000

40 >1.000 to 1.500

20 >0.500 to 1.000

0 <= 0.500

PCA Capital and Leverage Thresholds

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PCA Threshold Requirements

PCA Capital Category Common Equity

Tier 1 RBC %

Tier 1 Risk-Based Capital (RBC) Total

RBC %

Generally Applicable Tier 1

Leverage (percent)

Supplementary leverage ratio for advanced approaches banking organizations %

Supplementary leverage ratio for subsidiary IDIs of

top-tier US BHCs % Current %

Interim Final Rule %

Well Capitalized ≥ 6.5 ≥ 6.0 ≥ 8.0 ≥ 10.0 ≥ 5.0 Not applicable >= 6

Adequately Capitalized ≥ 4.5 ≥ 4.0 ≥ 6.0 ≥ 8.0 ≥ 4.0 >= 3 >= 3

Undercapitalized < 4.5 < 4.0 < 6.0 < 8.0 < 4.0 < 3 < 3

Significantly undercapitalized < 3.0 < 3.0 < 4.0 < 6.0 < 3.0 Not applicable Not applicable

Critically undercapitalized Tangible Equity to Total Assets ≤ 2%

Not applicable Not applicable

- Revised PCA ratios are effective on January 1, 2015, for all banks

- Tangible Equity equals the revised Tier 1 Capital plus outstanding non-Tier 1 perpetual preferred stock

- The Supplementary Leverage Ratio includes many off-balance sheet exposures in its denominator; the generally applicable leverage ratio does not

Liquidity Coverage Ratio

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Stock of high quality liquid assets (HQLAs)

Net cash outflows over a 30-day time period>= 100%

Net Stable Funding Ratio • Longer term Funding

• NSFR =

• Available Stable Funding (ASF)/ Required Stable Funding (RSF)>100%

• ASF – available reliable sources of funds over a 1-year period under

conditions of extended stress • Tier 1 and Tier 2 capital, preferred stock with maturity > 1 year, liabilities with

maturity > 1 year, stable deposits and funding with maturities < 1 year.

• Each weighted according to perceived availability and stability

• RSF – sum of the various types of various types of assets held and funded by a bank and off-balance sheet contingent exposures incurred and other bank activities that could expose it to liquidity risk • Each weighted according to perceived likelihood of funding needs

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Disparate Rules and Impacts

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Asset

Rank

Banking

Organization

Adv'd

Apprch

Banking Orgs

G-SIB

Flag

Revsd

Cap'l Rule,

w/ revsd

RWAs

Grand-

fathered

Cap'l

Items

AOCI

Opt-

out

CET1

Cap'l

Cnsvtn

Buffer

CET1

Counter-

cyclical

Buffer

CET1 G-

SIB Sur-

charge

LR SLR eSLR LCRMod

LCRNSFR

CCAR

BHCs

CapPR

BHCs

Annual

Firm-run

Stress

Tests

D-FAST -

1 Mid-

cycle, 2

annual

Living

Will

1 JPMorgan Chase 1 1 x x 1 1 x 1 1 1 TBD 1 1 1

2 Bank of America 2 2 x x 2 2 x 2 2 2 TBD 2 2 2

3 Citigroup 3 3 x x 3 3 x 3 3 3 TBD 3 3 3

4 Wells Fargo 4 4 x x 4 4 x 4 4 4 TBD 4 4 4

5 Goldman Sachs 5 5 x x 5 5 x 5 5 5 TBD 5 5 5

7 Morgan Stanley 6 6 x x 6 6 x 6 6 6 TBD 6 6 6

11 US Bank 7 x x 7 x 7 7 TBD 7 7 7

12 Bank of NY Mellon 8 7 x x 8 7 x 8 7 8 TBD 8 8 8

13 PNC 9 x x 9 x 9 9 TBD 9 9 9

14 HSBC 10 x x 10 x 10 10 TBD 1 10 10

15 Capital One 11 x x 11 x 11 11 TBD 10 11 11

16 State Steet 12 8 x x 12 8 x 12 8 12 TBD 11 12 12

18 TD Bank x x x x 1 TBD 12 13 13

19 BB&T x x x x 2 TBD 12 14 14

20 Suntrust x x x x 3 TBD 13 15 15

21 American Express 13 x x 13 x 13 4 TBD 14 16 16

22 Ally Bank x x x x 5 TBD 15 17 17

25 Fifth Third x x x x 6 TBD 16 18 18

27 RBS Citizens x x x x 7 TBD 2 19 19

28 Regions x x x x 8 TBD 17 20 20

29 BMO Harris x x x x 9 TBD 3 21 21

30 Santander x x x x 10 TBD 22 22

31 Union Bank x x x x 11 TBD 4 23 23

32 Northern Trust 14 x x 14 x 14 12 TBD 5 24 24

33 KeyCorp x x x x 13 TBD 18 25 25

34 M&T x x x x 14 TBD 6 26 26

35 Bank of the West x x x x 15 TBD 13 27 27

36 Discover x x x x 16 TBD 7 28 28

37 BBVA Compass x x x x 17 TBD 8 29 29

38 Deutsche Bank x x x x 18 TBD 14 30 30

39 Comerica x x x x 19 TBD 9 31 31

40 Huntington x x x x 20 TBD 10 32 32

41 Zions x x x x 21 TBD 11 33 33

Banking Orgs $15 bil >=

assets < $50 bilx x x x x

Banking Orgs $10 bil >=

assets < $15 bil x x x x x x

Banking Orgs with

total assets < $10 bilx x x x x

Capital Rules, with Revised RWAs Leverage Ratio LiquidtySpecial Category CCAR BHCs DFA Items

IMPLICATIONS OF BASEL III CHANGES

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What to do now? • Take inventory – where do we stand now?

• May require extensive disaggregation of data into new RWA, liquidity, capital and leverage categories (now 17 RWA categories) • Requires reading and interpreting hundreds of pages of regulator documents

• Systems may require updates and programming to accommodate new categories

• Changes to call reports are extensive, especially to Schedule R (regulatory capital and risk weighted assets [stay tuned])

• Organization structure and oversight committees

• Run current numbers through new paradigm model • If we do nothing, are we in or out of compliance • What are the best methods to improve the picture ?

• Giant puzzle - Linear programming model • Objective function – (e.g., maximize profits) • Variables (balances, rates, risk-weightings, etc.) • Constraints (minimum and maximum ratios,) • Run optimizations

• Benefits if you do something versus risks of doing nothing 26

What to Consider? • Options to consider:

• Capital: • Determine whether you should Opt-Out of AOCI changes • Replace non-qualifying forms of capital with qualifying forms • Raise new capital in qualifying forms • Divest of assets that are deductions from CET1

• Assets • Discontinue marginally profitable activities involving highly risk-weighted assets or

illiquid assets • Divest of assets with high RWA factors • Focus on high quality liquid assets • Collateralize more transactions

• Off-balance sheet items • Change form of unfunded commitments, and trim excess commitment amounts • Highly scrutinize counterparties and guarantors • Evaluate differing forms of structured transactions

• Funding sources and types • Lengthen maturities of deposits and debt • Put more emphasis on stable forms of funding

• Mergers and Acquisitions • Understand the Basel III- related ramifications of any transaction

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Strategic Questions • How will phasing in of new requirements affect my growth and business plans?

• How long does each potential strategy I might pursue take to implement versus how much time I have to be in compliance?

• What are the trade-offs between yield, fees, and capital charges that I need to consider to maintain an acceptable ROE and have no dividend or bonus restrictions?

• What Implementation costs will I face and can I pass any of these costs on to my customers directly or through other revenue sources?

• To what extent will the market impose uniform standards on all types and sizes of entities, regardless of disparate regulatory adoption requirements and timelines?

• Basel III is important, but just one piece of the puzzle that needs to be considered:

• How do Basel III, Dodd-Frank, QM, QRM, CFPB, Regulation AB, massive lawsuit settlements, and other market changes and dynamics interact?

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Real World Case Study Examples

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Systems and Record-Keeping • Increased complexity requires more granularity in general ledger and

systems of record:

• More categories: • Risk-weighted assets, high quality liquid assets, funding maturities and types,

investments, off-balance sheet items, capital instruments

• Call reports have many more pages, fields and inter-relationships to track and program systems

• Systems will need to support extensive new internal and external reporting needs

• Planning and forecasting systems will need to be programmed

• Compliance and profitability trade-offs must be examined

• Need way of tracking and matching counterparties and guarantors to assets

• Need tighter scrutiny of commitments – excess amounts will be a drain on capital

• Increased regulator scrutiny and reporting requirements

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Capital Ratio Implications • Multi-prong approach may be necessary:

• Raise new capital or replace existing non-qualifying capital

• Reduce assets that are direct reductions of capital

• Alter asset mix to encompass lower risk-weighted assets

• Increasing capital may:

• Reduce funding costs (less debt)

• Increase net income

• But at a reduced ROE

• Capital ratios, leverage ratios, and liquidity ratios need to be considered in unison

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Shedding Assets Causing Deductions From Capital

32

Source: www.globes-online.com 8-7-2014

Selling MSRs – Strong price and Improved Capital Ratios

33

Selling MSRs removes an asset that causes a in dollar-for-dollar reduction in CET1 for assets amounts above the 10% or CET1 limit. It also reduces RWAs, as the 10% piece not resulting in CET1 reduction is subject to a 250% risk-weighting.

Implications on customer ownership, customer service, and cross-selling opportunities

• Certain activities will move toward the less regulated shadow banking sector as the regulatory cost to banks to undertake such activities increases

• The interconnectedness of banks with nonbank entities will be challenged by supervisors

• Key example is mortgage servicing assets:

• Basel III has let to an increasing concentration of servicing held by less regulated, non-bank firms such as mortgage companies, REITs, hedge funds, and private equity firms that are not subject to the new capital restrictions.

• Banks are either selling loans servicing released or selling servicing rights separately

34

One strategy - Banks can sell MSR assets but retain subservicing to keep customer relationships

35

FHFA Using Approval Rights as One Means of Control

36

NY DFS is Delaying Transactions

37

Risk-Weighted Asset Implications

• Increased risk weighting on certain on and off-balance sheet exposures has a dual impact on capital ratios and liquidity ratios

• First goal is to see determine which exposure provide greatest boast in both ratio types through their elimination

• Rank by impact

• Examine profitability of each

• Take strategic actions to shed high capital and liquidity cost, low cash return assets

• MSRs

• Stock and debt in other financial institutions

• High Velocity Commercial Real Estate Assets

• Excessive unused commitments

• Certain trading assets and derivative exposures

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Implications on Business Lines – Reducing Marginally Profitable Assets to Meet Leverage Ratios

39

Implications on Commitments

• Reduction in size of commitments

• Efforts to make commitments unconditionally cancellable where practical

• Unconditionally cancellable commitments have a O% risk weighting for capital ratios but 10% for liquidity ratios

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Implications on Product Design

• Transform unsecured credit into credit secured by collateral such as real property or cash

• Shift certain customers from credit products to debit products

• Transform long credit exposure durations (grace periods, billing cycles, credit limits) into shorter durations, particularly for non-revolving customers

• Transform contingent liabilities, especially unused credit lines (even internal guidance lines), into just in time, or case by case, underwriting

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Liquidity Ratio Implications • Institutions are encouraged to put liquid assets and longer-term

funding on balance sheet

• Challenge is the liquid assets yield less and longer-term funding costs more

• Combined with higher capital needs, ROEs can suffer

• Banking organizations are meeting the challenge by cutting low margin businesses that have high risk-weighting or that involve very short-term funding

• Retail units that raise deposits (viewed as stable funding) can gain greater emphasis

42

Implications on Business Lines – Cutting Certain Types of Lending to Meet Liquidity Ratios

43

The letter asks these so-called “stock borrow transactions” not to be classified as loans by the bank for the purposes of the new funding rules.

Implications on Growth and M&A • Growth by acquisition may lead to greater and more onerous

requirements:

• Loss of grandfathering of TruPS and other capital instruments if growth is through acquisition

• AOIC Opt-out election status of combined entities

• Combined entity may move into a new asset-size bracket and the resulting increase in capital, reporting and stress testing requirements

• Desire not to just edge into new category

• > $10 billion, > $50 billion, Advanced Approaches

• Goodwill in a transaction results in a dollar-for-dollar reduction in CET1

• Generic growth may also result in some of these issues

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Growth into New Asset Size Category Affects Plans

45

Source: Wall Street Journal 7-22-2014

Systemically Important Tag Draws Ire from Large Regional Banks

46 Source: Wall Street Journal, July 31, 2014

FSOC Designates MetLife as Systemically Important on 9-4-2014 – Subjects Company to Stress Tests and Living Will Requirements

47

Competitive Comparative Analytics discussion

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COMPARATIVE FINANCIAL ANALYSIS

CCF

Factor

Risk

Wtg

Banking Org

< $15 billion

Banking Org

>=$ 15 bil <

$50 bil

Banking Org

>=$ 50 bil <

$250 bil

Banking Org

>=$ 250 bil <

$700 bil

G-SIB

Banking Org

Small

Mortgage

Company

Large

Mortgage

Company

REIT

1. Cash and balances due from

depository institutions 0%

2. Securities excluding securitization

exposures

a. Held-to-maturity securities

b. Available-for-sale securities

3. Federal funds sold and securities

purchased under agreements to

resell

4. Loans and leases held for sale

a. Residential mortgage exposures50%

b. High volatility commercial real

estate exposures 150%

c. Exposures past 90 days or more

or on nonaccrral 100%

c.1 1-4 family mortgage 100%

c.2 Other exposures 150%

d. All other exposures 100%

5. Loans and leases, net of unearned

income…

a. Residential mortgage exposures50%

b. High volatility commercial real

estate exposures 150%

Completed analysis will be Discussed in Presentation

Berkshire Group Contacts

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The Berkshire Group is a management consulting firm providing advisory services, predictive analytics, due diligence services and data subscription products to banking organizations and other financial institutions. For more information, please visit www.bglp.com. If we can be of assistance to your organization, please contact one of the parties below:

Michael W. Trickey Managing Director O: 847-540-6554 x204 C: 847-867-3595 Email: mtrickey@bglp.com

Jim Reynolds Senior Director C: 415-971-0026 Email: jreynolds@bglp.com

Debra Vander Weit Consulting Director O: 847-540-6554 x206 C: 847-867-3595 F: 847-540-6548 Email: dvanderweit@bglp.com

David Stinner Director O: 301-216-9776 C: 301-908-1531 Email: dstinner@bglp.com

Berkshire Group LP 553 Capital Drive Lake Zurich, IL 60047 O: 847-540-6554 Email: sales@bglp.com Web: www.bglp.com