Basel III Capital Rules Finally Final III Capital Rules Finally Final What Does It Mean? About the...
Transcript of Basel III Capital Rules Finally Final III Capital Rules Finally Final What Does It Mean? About the...
August 29, 2013
Andrew K. Gibbs, CFA, CPA/ABV Mercer Capital
Ralph F. “Chip” MacDonald, III Jones Day
Jeff K. Davis, CFA Mercer Capital
Basel III Capital Rules Finally FinalWhat Does It Mean?
About the Speakers Andrew K. Gibbs, CFA, CPA/ABV
Andrew K. Gibbs leads Mercer Capital’s Depository Institutions practice. He provides valuation and corporate advisory services to banks, thrifts, and credit unions for purposes including ESOPs, mergers and acquisitions, profit sharing plans, estate and gift tax planning, compliance matters, and corporate planning. In addition, Andy directs projects related to the valuation of intangible assets under Accounting Standards Codification (“ASC”) 805 and impairment testing under ASC 350.
Andy has extensive experience working with depository institutions in merger and acquisition advisory engagements. He assists buyers in evaluating the attractiveness of acquisition candidates, determining a price for the target institution, structuring the transaction, and evaluating different forms of financing. For sell-side clients, Andy analyzes the potential value that the institution may receive upon a sale, assists in locating potential buyers, and participates in negotiating a final transaction price and merger agreement.
Andy is a frequent speaker on issues related to community bank valuation and is the co-author of three books: The ESOP Handbook for Banks, Acquiring a Failed Bank, and The Bank Director’s Business Valuation Handbook.
Ralph F. “Chip” MacDonald, III
Chip’s practice emphasizes securities, mergers and acquisitions, corporate governance, financial institutions (including REITs, investment managers, and broker-dealers), and financial products. His professional affiliations include the American Bar Association (Business Law Section), Alabama State Bar (chairman, Banking Business and Corporation Law Section, 1986-1987), and Atlanta and Georgia Bar Associations. Chip is featured in The Best Lawyers in America, Chambers USA “Leading Lawyers,” Best Lawyers in Atlanta, Georgia Super Lawyers (2007), and in Who’s Who Legal (2007). He is a frequent speaker and author on matters related to financial and investment services and products.
Jeff K. Davis, CFA
Jeff K. Davis is the Managing Director of Mercer Capital’s Financial Institutions Group. Prior to rejoining Mercer Capital, Davis spent 13 years as a sell-side analyst providing coverage of publicly traded banks and specialty finance companies to institutional investors evaluating common equity and fixed income investment opportunities. Jeff was most recently Managing Director of Guggenheim Securities, LLC, and was previously head of the Financial Institutions Group at FTN Equity Capital Markets. While at Mercer Capital in the 1990s, Jeff led the firm’s financial institutions practice, providing valuation and transaction advisory services.
Jeff is a speaker at industry gatherings, including SNL Financial/University of Virginia’s annual analyst training seminar, the ABA, various state banking meetings as well as security industry gatherings. Additionally, he regularly makes presentations to boards of directors and executive management teams.
He is a periodic guest on CNBC, Bloomberg TV and Bloomberg Radio and is quoted in the American Banker, the Wall Street Journal, Reuters, Forbes and other media outlets. Presently, he is an editorial contributor to SNL Financial.
Basel III Capital Rules Finally Final!
1!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
1
2
Outline for Today’s Presentation
PART ONE
Basel III Regulations PART TWO
Implications PART THREE
Regulatory Materials & Citations
Basel III Capital Rules Finally Final!
2!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
3
FINALIZED BASEL III REGULATIONS
SECTION ONE
4
What Does Basel III Do?
§ Revises the definition and categories of capital for banks, thrifts,
bank holding companies and thrift holding companies, and other
nonbank financial companies supervised by the Federal Reserve
§ Dodd-Frank Act, Section 171 (the “Collins Amendment”) requires
holding companies to maintain the same types and levels of leverage
capital and risk based capital as banks.
§ A new Common Equity Tier 1 Risk-Based Capital Ratio (“CET1”)
§ A capital conservation buffer of 2.50% where noncompliance
reduces or eliminates capital distributions and management
bonuses
Basel III Capital Rules Finally Final!
3!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
5
What Does Basel III Do?
§ A countercyclical buffer also is required for the largest banks
§ Changes various capital additions, deductions and adjustments
§ Changes certain on and off-balance sheet risk weightings
6
What Does Basel III Do?
§ Federal Reserve – July 2, 2013 (subject to finalization in
the Federal Register)
§ OCC – July 9, 2013 – identical to the Federal Reserve’s
July 2, 2013 rule
§ FDIC – July 9, 2013 – Interim Final Rule seeking
comments, especially as to SIFIs
Basel III Capital Rules Finally Final!
4!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
7
What Does Basel III Do?
§ Effective Dates and Phase-Ins
§ January 1, 2015 for standardized approaches banks
§ January 1, 2015 for new PCA rules
§ Various minimum capital ratios phased in
§ AOCI opt-out date – first Call Report or Y-9 after January 1,
2015 for standardized approaches banks
§ January 1, 2016 to January 1, 2019 for capital conservation
buffer
8
Potential Effects of Basel III
§ Capital Minimums are increased.
§ Types of capital are more limited:
§ No new trust preferred with phase out of existing trust preferred for banks over $15 billion of
assets. Smaller banks’ Trust Preferreds are grandfathered.
§ Common stock and perpetual noncumulative preferred stock are most valuable under the
regulations
§ Voting common stock should be a majority of CET1
§ The terms of capital instruments, especially subordinated debt, are changed
§ All buyback and redemptions of capital will be subject to prior regulatory scrutiny and
approval
§ The Prompt Corrective Action (“PCA”) Rules of FDI Act, Section 38 are
revised to reflect the new capital measures, and will affect deteriorating
banks more quickly.
Basel III Capital Rules Finally Final!
5!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
9
Potential Effects of Basel III
§ Risk weightings of assets and off-balance sheet exposures are revised in
various cases.
§ The amounts and risk weights of certain assets will require better capital
planning, and may cause capital to be reallocated internally to seek better
returns on investment.
§ The changes in treatment of deferred tax assets and the increased risk
weights on NPAs will cause problem banks to be resolved or recapitalized
faster.
§ The value of DTAs will be diminished.
§ Banks will need continuing and better access to the capital markets.
§ Returns and shareholder value will depend on improved capital planning.
10
Other Facts that Affect Regulatory Capital
§ Banking organizations with high levels of risk are also expected to operate even
further above minimum standards. In addition, the supervisory assessment
takes into account the quality and trends in a banking organization’s capital
composition, including the share of common and non-common equity capital
elements.
§ A banking organization must maintain capital commensurate with the level and
nature of all risks to which it is exposed and that a banking organization have a
process for assessing its overall capital adequacy in relation to its risk profile,
as well as a comprehensive strategy for maintaining an appropriate level of
capital.
§ The supervisory evaluation of a banking organization’s capital adequacy, may
include such factors as whether the banking organization is newly chartered,
entering new activities, or introducing new products.
Basel III Capital Rules Finally Final!
6!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
11
Other Facts that Affect Regulatory Capital
§ Whether a banking organization is receiving special supervisory attention, has or is
expected to have losses resulting in capital inadequacy, has significant exposure
due to risks from concentrations in credit or nontraditional activities, or has
significant exposure to interest rate risk, operational risk, or could be adversely
affected by the activities or condition of a banking organization’s holding company.
§ A banking organization should have an appropriately rigorous process for assessing
its overall capital adequacy in relation to its risk profile and a comprehensive
strategy for maintaining an appropriate level of capital, consistent with the
longstanding approach employed by the agencies in their supervision of banking
organizations. Supervisors would evaluate the comprehensiveness and
effectiveness of a banking organization’s capital planning in light of its activities and
capital levels. An evaluation of the level of sophistication of an individual banking
organization’s capital adequacy process would be commensurate with the banking
organization’s size, sophistication, and risk profile, similar to the current supervisory
practice.
12
_________
CPE Code
Basel III Capital Rules Finally Final!
7!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
13
Capital
§ CET1
§ Generally common equity, retained earnings, accumulated other
comprehensive income (“AOCI”) (subject to one time opt out election)
and “common equity minority interest”
§ Reduced by:
§ Goodwill and intangibles (excluding mortgage servicing rights (“MSAs”))
net of associated deferred tax liabilities (“DTLs”);
§ Deferred tax assets (“DTAs”) arising from tax NoLs and tax credit
carryforwards net of allowances and DTLs;
§ Gains on sale from any securitization exposure; and
§ Defined benefit pension fund net asset (i.e. excess plan assets) net of
associated DTLs, unless the bank has unrestricted/unfettered access to the
fund’s assets.
14
Capital
§ Adjusted for, where an AOCI opt out is made
§ Unrealized gains and losses on AFS securities, AFS preferred stock classed as
“equity” under GAAP, accumulated net gain or net loss on cash flow hedges at
FMV on the balance sheet, among others; and
§ Unrealized gains and losses due to changes in the fair values of liabilities
resulting from changes to the bank’s credit risk
§ Reduced further by these “threshold deductions” of the following that are
individually greater than 10% of CET1 or collectively greater than 15% of
CET1 (after above deductions):
§ MSAs
§ DTAs
§ Significant common stock investments in unconsolidated financial institutions
Basel III Capital Rules Finally Final!
8!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
15
Capital
§ Additional Tier 1 Capital
§ Noncumulative perpetual preferred stock
§ Tier 1 minority interest not in CET1, subject to limits
§ Current Tier 1 capital instruments issued under TARP and SBLF
§ Tier 2 Capital
§ Preferred stock and most current subordinated debt;
§ Total capital minority interest not included in Tier 1 capital, subject to limits;
§ ALLL, up to 1.25% of total risk-weighted assets (“RWA”);
§ Tier 2 capital instruments issued under TARP and SBLF; provided
§ These instruments meet the requirements of Rule ___.22.
16
Capital Ratios
1 20% per year phase in starting 2015.
2 6.625%, 7.25%, 7.875% for 2016, 2017 and 2018, respectively.
3 8.625%, 9.25% and 9.875% in 2016, 2017 and 2018, respectively.
Jan. 1, 2015
Fully Phased in Jan. 1, 2019
Minimum CET1 / RWA 4.50% 4.50%
CET1 Conservation Buffer - 2.50%
Total CET1 4.50% 7.00%
Deductions and threshold deductions1 40.00% 100.00%
Minimum Tier 1 Capital 6.00% 6.00%
Minimum Tier 1 Capital plus capital conservation buffer2 -
8.50%
Minimum Total Capital 8.00% 8.00%
Minimum Total Capital plus conservation buffer3 8.00%
10.50%
Basel III Capital Rules Finally Final!
9!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
17
Capital Ratios
Minimum Ratios
Current Basel III
CET1 / RWA - 4.5%
Leverage Ratio 4.0% 4.0%
Tier 1 capital/RWA 4.0% 6.0%
Total capital/RWA 8.0% 8.0%
Capital conservation buffer - 2.50%
18
Prompt Corrective Action Categories Effective January 1, 2015
Minimums
Current Basel III
Well-Capitalized
CET1 - 6.5%
Tier 1 risk-based capital 6.0% 8.0%
Total risk-based capital 10.0% 10.0%
Tier 1 leverage ratio 5.0% 5.0%
Undercapitalized
CET1 - < 6.0%
Tier 1 risk-based capital < 4.0% < 6.0%
Total risk-based capital < 8.0% < 8.0%
Tier 1 leverage ratio < 5.0% < 4.0%
Critically undercapitalized Tangible equity to total assets ≤ 2.0%
Tangible equity to total assets ≤ 2.0%
Basel III Capital Rules Finally Final!
10!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
19
Capital Conservation Buffer
§ The capital conservation buffer amount does not affect PCA levels.
§ Capital conservation buffer deficiencies may restrict or limit
dividends, share buy-backs and distributions on Tier 1 capital
instruments (“capital actions”) and discretionary bonuses based on
the amount of “eligible retained earnings.”
§ “Eligible retained earnings” means the most recent 4 quarters of net
income less capital distributions (net of certain tax effects, if the tax
effects are not already included in net income.
20
Capital Conservation Buffer
§ Calculation of the capital conservation buffer:
§ Subtract the Basel III minimum ratios for each of CET1 (4.5%),
Tier 1 Risk-Based Capital (6.0%) and Total Risk-Based Capital
Ratio (8.0%) from the bank’s actual capital under each of these
measures.
§ The actual buffer used to determine capital actions and
discretionary bonuses is the lowest buffer percentage for all 3
capital ratios.
§ If any of these capital ratios is less than the minimum required,
the capital conservation buffer is zero.
Basel III Capital Rules Finally Final!
11!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
21
Capital Conservation Buffer
§ Fully phased in buffer limits on capital actions and discretionary bonus are
subject to regulatory discretion in light of bank risk, CCAR, enforcement
actions, etc.
§ The phase in occurs January 1, 2016 to January 1, 2019.
Buffer %
Buffer % Limit
More than 2.50% None
> 1.875% ≤ 2.50% 60.0%
> 1.250% ≤ 1.875% 40.0
> 0.625% ≤ 1.250% 20.0
≤ 0.625 - 0 -
22
Selected Standardized Approach Risk Weights
§ One-to-Four Family, First Lien Residential Mortgages
§ Significant changes from 2012 Proposal
§ Considerably simplified from 2012 Proposal
§ 50% risk weight when made in accordance with prudent underwriting
standards on owner-occupied or rented properties
§ 100% on all others
§ The banking agencies may develop and propose changes in the
treatment of residential mortgages taking into account market,
regulatory and product developments, and implementation issues
Basel III Capital Rules Finally Final!
12!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
23
Selected Standardized Approach Risk Weights
§ High Volatility CRE
§ Includes ADC loans, except where the LTV is less than regulatory maximums
and the borrower has contributed before the loan is made and maintains at all
times equity of 15% of the project’s “as completed” value
§ Other exceptions include 1-4 family residences, certain community development
investments, and the purchase and development of agricultural land
§ 150% risk weight
§ Past due assets – 150% risk weight
§ Does not apply to HVCRE and 1-to-4 family residential mortgages
§ Structured securities, including private label mortgage securities, trust
preferred CDOs and ABS – up to 1,250%
24
Selected Standardized Approach Risk Weights
§ Substitutions for risk weights
§ Generally, risk weight applicable to collateralized portion of the exposure cannot
be less than 20%
§ Collateral (U.S. government securities or cash) – may decrease risk weight from
20% to 0%
§ Guarantees may reduce risk weights to that of an applicable guarantor
§ MSAs – 250% risk weight to extent not deducted from capital subject to the
10% / 15% of CET1 maximums
§ DTAs – 250% risk weight to the extent not deducted from capital subject to
the 10% / 15% of CET1 maximums
§ Equity exposures other than FRB, FHLB and CDFIs – 250% to 600% risk
weight
Basel III Capital Rules Finally Final!
13!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
25
_________
CPE Code
26
IMPLICATIONS
SECTION TWO
Basel III Capital Rules Finally Final!
14!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
27
Implications
Positive § Years of uncertainty resolved
§ More capital = resilient system
§ Preferred and sub-debt remain viable
capital supplements
§ Trust preferred grandfathered for
BHCs with < $15B of assets
§ Ability to opt-out of AFS mark
embedded in AOCI for non-advanced
approaches banks
§ Residential mortgages not subjected
to enhanced risk-weighting
Negative § Lower ROE (and ROTE)
§ Less distribution capacity
§ Smaller industry asset base = less
credit to the economy
§ Pro-cyclical nature = incentive to
exceed conservation buffers
§ Some businesses ceded to specialty
finance
§ Higher capital requirements another
incentive-but not a mandate-for banks
to merge
28
Capital Planning
§ Regulators and Basel III require more and better planning, or these
drivers of shareholder value may become less consistent and less
valuable to investors
§ Regulatory capital rules do not encompass all risks, including
operational risks and the “amplification of risks through correlations,
concentrations and the business cycle”
§ Capital planning is a responsibility of the board of directors and
part of directors’ duties
§ Failure to properly plan for capital may be an unsafe and unsound
practice
Basel III Capital Rules Finally Final!
15!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
29
Capital Planning
§ Banking organizations contemplating expansion need capital well above
regulatory minimums for “well capitalized” organizations
§ More risks, including concentrations and correlated assets and funding,
require more capital
§ Planning varies with size, complexity, and risk profile
§ Capital planning and capital levels are affected by:
§ Corporate governance
§ Risk management
§ Internal controls
§ The complexity and risks of product lines
§ Earnings
§ Access to capital
30
Capital Planning
§ Organizations with TARP, SBLF, and non-grandfathered
trust preferreds need to be especially proactive in
planning to replace these
§ Stress testing is not mandated under Basel III or Dodd-
Frank for banks with less than $15 billion of assets, but
assume an expectation to implement
§ We view annual stress testing as a good exercise even if
the future at best only rhymes with the past
Basel III Capital Rules Finally Final!
16!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
31
Capital Planning
§ Capital planning dovetails with value planning:
§ Optimize parent capital structure – margin of safety
vs. (some) leveraging to enhance ROE
§ Capital for organic and M&A growth
§ Appropriate distribution policy – greater importance
to shareholder return when growth is modest
32
Capital Planning
§ Parent company capital structure remains the focus given intent to
reduce parent double leverage
§ Bank-level capital levels comfortably above Basel III mandates due
to: (a) improved profitability; (b) weak loan growth; and (c) parent
leverage used to create equity in the bank
§ Risk-weighting pressure on capital lessened today via reduction in
ADC, CDOs, etc. … banks will have to extract extra yield as
demand for higher risk-weighted assets improves
§ If Fed maintains ZIRP, we think banks will find a receptive market
for coupon capital and senior debt
Basel III Capital Rules Finally Final!
17!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
33
Capital Planning
Bank-Level Capital Profile
Tier 1 Common / RWA Deciles
Tier 1 Common / RWA
Leverage Ratio
Total Risk-‐Based Ratio
Texas Ratio
NPAs / Loans + OREO
YTDROA
Number of Banks
1st 37.11 17.27 37.97 3.0 1.74 0.74 697
2nd 24.11 12.45 25.20 9.1 2.15 0.78 697
3rd 20.14 11.24 21.24 11.1 2.33 0.77 699
4th 17.76 10.80 18.93 13.2 2.52 0.82 696
5th 16.12 10.22 17.26 13.6 2.43 0.81 693
6th 14.89 9.85 16.09 15.7 2.53 0.86 699
7th 13.80 9.59 15.02 18.1 2.71 0.85 696
8th 12.84 9.25 14.01 17.9 2.49 0.84 702
9th 11.73 8.97 12.95 16.7 2.24 0.89 696
10th 10.02 7.89 11.38 29.5 3.47 0.64 699
Bank Median of Decile (%)
Source: SNL Financial
34
Capital Planning Parent-Level Tier 1 Common Equity
Chart reflects current calculation of Tier 1 common equity and risk-weighted assets (i.e., does not give effect to Basel III) Data set includes bank holding companies with assets less than $5 billion filing form FR Y-9C at June 30, 2013 Source: SNL Financial, Mercer Capital research
Basel III Capital Rules Finally Final!
18!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
35
Capital Planning Parent-Level Capital Structure
Chart reflects current calculation of Tier 1 common equity and risk-weighted assets (i.e., does not give effect to Basel III) Data set includes bank holding companies with assets less than $5 billion filing form FR Y-9C at June 30, 2013 Source: SNL Financial, Mercer Capital research
36
Capital Planning Parent-Level Capital Structure
Chart reflects current calculation of Tier 1 common equity and risk-weighted assets (i.e., does not give effect to Basel III) Data set includes bank holding companies with assets less than $5 billion filing form FR Y-9C at June 30, 2013 Source: SNL Financial, Mercer Capital research
Basel III Capital Rules Finally Final!
19!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
37
Capital Planning
Tier 1 Common / RWA Deciles
Tier 1 Common / RWA
Leverage Ratio
Total Risk Based Ratio
Double Leverage Ratio
TruPs / Tier 1 Capital
TruPs / Total RBC
YTD ROA
# of BHCs Filing Y-‐9C
1st 22.75 13.21 24.94 98 0.00 0.00 0.87 102
2nd 16.97 11.23 18.75 99 0.00 0.00 0.95 101
3rd 14.72 10.06 16.56 100 0.00 0.00 0.88 103
4th 13.41 10.04 15.39 100 2.87 2.71 0.87 98
5th 12.59 9.94 15.04 102 5.56 5.13 0.95 105
6th 11.79 9.44 14.30 104 6.29 5.72 0.89 102
7th 10.74 9.32 13.94 109 8.47 7.66 0.87 103
8th 9.58 9.34 13.81 114 15.47 13.75 0.78 105
9th 8.38 8.73 13.63 120 16.96 14.39 0.75 107
10th 4.76 5.49 11.10 143 25.77 22.23 0.25 109
Bank Holding Company Median of Decile (%)
Parent-Level Capital Profile
Source: SNL Financial
38
_________
CPE Code
Basel III Capital Rules Finally Final!
20!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
39
Valuation & Shareholder Return
§ Basic valuation framework:
§ Net Income / Assets x Assets / Equity = Net Income / Equity …
or ROA x Leverage = ROE
§ Net income / Equity x Price / Earnings = Price / Book … or
ROE x P/E = P/B
§ P/E in relation to normalized (core) earnings is
influenced by multiple factors … investors focus on
growth, franchise quality, M&A potential
§ … lower P/B (P/TB) multiples all else equal
40
Valuation & Shareholder Return
Source: FDIC
Bank-Level Return on Assets
Basel III Capital Rules Finally Final!
21!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
41
Valuation & Shareholder Return Bank-Level Leverage Ratio
Source: FDIC
42
Valuation & Shareholder Return Bank-Level Return on Equity
Source: FDIC
Basel III Capital Rules Finally Final!
22!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
43
Valuation & Shareholder Return
Source: FDIC and Federal Reserve’s H.15
§ ROE is low relative to 92-06 “great moderation”, but
§ Long-term average is for ROE to exceed 10-year US Treasury by
500-700bps
§ Current spread of 480-640bps for banks with assets > $100 million
is within historical norm
§ Investors and bankers have to reset their expectations with Basel III
and impact of Fed’s ongoing ZIRP
LTM 10-Yr Current Current84-89 90-99 00-07 08-12 00-12 84-12 ROE UST Spread v. 84-12
Assets > $10B 1.7% 7.4% 9.1% 3.3% 7.6% 7.1% 9.2% 2.8% 6.4% -0.6%
Assets $1-10B -1.7% 7.6% 8.3% -1.5% 6.8% 5.6% 9.0% 2.8% 6.2% 0.6%
Assets $100M-$1B -4.6% 5.7% 6.6% 0.4% 5.8% 5.0% 7.6% 2.8% 4.8% -0.2%
Assets < $100M -2.5% 3.8% 3.3% 0.5% 2.9% 2.4% 5.9% 2.8% 3.1% 0.6%All Insured Institutions -3.0% 7.1% 8.4% 2.2% 7.2% 6.6% 9.0% 2.8% 6.2% -0.3%
Bank-Level ROE Less 10-Year UST ("Spread")
44
Valuation & Shareholder Return
Basel III Capital Rules Finally Final!
23!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
45
Valuation & Shareholder Return
§ Valuations have rebounded from the 3Q11 sell-off (debt ceiling & European bank
issues)
§ P/Es approximate long-term average; P/TB does not because ROTE is lower in spite
of greatly reduced credit costs and outsized mortgage gains for many banks
Source: SNL Financial
Median Price/Earnings YE09 YE10 YE11 YE12 26-‐Aug YE09 YE10 YE11 YE12 26-‐Aug$100 Million -‐ $1 Billion 14.7x 13.6x 11.8x 11.5x 12.8x 13.6x 108% 100% 87% 84% 94%
$1 Billion -‐ $10 Billion 15.0x 15.1x 12.9x 12.9x 14.8x 14.3x 105% 106% 90% 90% 104%
> $10 Billion 19.1x 17.6x 13.4x 12.9x 15.5x 15.3x 125% 115% 88% 85% 101%
Average Acquisition P/E nm nm nm 33.5x 22.5x
Median Price/TBV YE09 YE10 YE11 YE12 26-‐Aug YE09 YE10 YE11 YE12 26-‐Aug$100 Million -‐ $1 Billion 75% 77% 68% 77% 92% 117% 65% 66% 59% 66% 79%
$1 Billion -‐ $10 Billion 108% 122% 105% 119% 144% 165% 66% 74% 64% 72% 87%
> $10 Billion 153% 155% 132% 134% 170% 219% 70% 71% 60% 61% 78%
Median Acquisition P/TBV 114% 116% 106% 114% 118%
20-‐ Year Average
20-‐ Year Average
Public Market P/E Relative to 20-‐Year Average
Public Market P/TBV Relative to 20-‐Year Average
46
M&A
46
No Basel III Wave Yet
Basel III Capital Rules Finally Final!
24!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
47
M&A Modest P/TBV Reflective of ROTE
48
Capital Raising
§ Markets generally are open to community and regional banks –
though pricing can be punitive if investors do not see growth or a
possible sale
§ Although trust preferred issuers obtained a break with Basel III,
many smaller banks still have parent capital structure issues due to
the pending re-pricing of TARP and SBLF preferred shares in 2014
and 2015 to 9% from 5%
§ Pools of institutional capital are available to purchase newly issued
preferred and sub debt
§ Institutional investors will be much more demanding than the typical
privately-held bank is accustomed to
Basel III Capital Rules Finally Final!
25!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
49
Capital Raising
§ Noncumulative perpetual preferred stock offerings rising in
frequency
Source: SNL Financial, Mercer Capital research
Aggregate Issuance ($000s) Median YieldPreferred
Stock Senior DebtSubordinated
DebtPreferred
Stock Senior DebtSubordinated
Debt
2013 YTD* $1,829,243 $982,954 $321,960 6.22% 5.75% 7.25%
2012 $1,509,725 $3,261,592 $628,825 6.58% 5.00% 6.90%
2011 $415,200 $2,238,096 $307,950 8.00% 5.00% 6.90%
2010 $35,062 $2,222,063 $533,241 9.00% 5.38% 8.00%
2009 $75,421 $1,357,236 $578,577 7.00% 9.00% 9.00%
* through August 27, 2013
1. Preferred stock offerings exclude convertible offerings, TARP/SBLF transactions (offerings and auctions), and offerings by banks with assets greater than $50 billion
2. Senior debt offerings exclude TLGP transactions and offerings by banks with assets greater than $50 billion
3. Subordinated debt offerings exclude convertible offerings and offerings by banks with assets greater than $50 billion
50
Capital Raising
2013 yield
ranges vs.
median ROE for
four BHC groups ($500M to > $10B)
Source: Wall Street Journal, SNL Financial and FFIEC
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10Y UST BBB Corp High Yield Preferred 2013 BHC ROE
Basel III Capital Rules Finally Final!
26!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
51
Sub Debt & Shelf Registration Statements
§ Basel III will require updates to existing shelf
registration statements and changes to
instruments registered
§ If you do not have a shelf registration statement,
you need one!
§ The required terms of subordinated debt are
especially changed
52
S Corporations
§ S Corps disadvantaged
§ Capital conservation buffer may limit distributions to fund pass-through
tax liability
§ More potential volatility to capital ratios, buffers, and eligible retained
earnings in periods of losses
§ Final rules did not permit an exception for distributions to cover taxable
income
§ Note in the following example that the S corporation would be
unable to make distributions in period 3 because it has negative
eligible retained earnings, while the C corporation could pay
dividends
Basel III Capital Rules Finally Final!
27!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
53
S Corporations C Corporation S Corporation
Bank Perspective Period 1 Period 2 Period 3 Period 1 Period 2 Period 3
Common Equity Tier 1 Capital $7,100 $6,232 $7,100 $5,700
+ GAAP Pre-Tax Income / (Net Loss) (1,400) 260 (1,400) 260
+ GAAP Income Tax Effect @38% 532 (99) 0 0
- Dividends 0 (13) 0 0Common Equity Tier 1 Capital $7,100 $6,232 $6,380 $7,100 $5,700 $5,960Eligib le Retained Earnings $900 $32 $180 $900 ($500) ($240)
Risk-Weighted Assets 100,000 100,000 100,000 100,000 100,000 100,000
CET1 / RWA 7.10% 6.23% 6.38% 7.10% 5.70% 5.96%Capital Conservation Buffer 2.60% 1.73% 1.88% 2.60% 1.20% 1.46%
Buffer Limit on Bonuses/Dividends 0% 40% 60% 0% 20% 40%
Shareholder Perspective
Dividends $0 $13 na na
Pass-Through Taxable Income na na 260 260
Taxable Income $0 $13 $260 $260
x Applicable Tax Rate 20.0% 20.0% 40.0% 40.0%= Shareholder Tax Obligation $0 $3 $104 $104
Dividends $0 $13 $0 $0
- Shareholder Tax Obligation 0 (3) (104) (104)= After-Tax Shareholder Cash Flow $0 $10 ($104) ($104)
54
Counter-Cyclicality
§ Capital ratios become more sensitive to deterioration in
the institution’s performance than under the existing
rules
§ Deduction of DTAs relating to net operating losses from Tier 1
common
§ Increased risk weightings applied to past-due loans
§ Assuming no DTA impact on CET1, an increase in past-due
loans from 1% to 10% of the portfolio causes an impact of 0 to
29 basis points on the Tier 1 common capital ratio, depending
on the pre-existing risk weighting category of the loans
Basel III Capital Rules Finally Final!
28!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
55
Counter-Cyclicality
Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 4
Tier 1 Capital Ratios -- Sensitivity to Rising Past-Due Loans Normal Past-
Dues
10% Past-Dues; Proportionate
Increase
10% Past-Dues; 100% of
Deterioration in 1-4 Family
10% Past-Dues; 100% of
Deterioration in Non 1-4 Family
10% Past-Dues; 100% of
Deterioration in HVCRE
Common Equity Tier 1 Capital $20,000 $20,000 $20,000 $20,000 $20,000
Risk-Weighted Assets $278,500 $286,455 $278,500 $290,200 $278,500
Tier 1 Common / RWA 7.18% 6.98% 7.18% 6.89% 7.18%
Risk-Weight
1-4 Loans 50.0% $58,000 $52,727 $34,600 $58,000 $58,000
Non 1-4 Loans 100.0% 175,000 159,091 175,000 151,600 175,000
HVCRE Loans 150.0% 24,400 22,182 24,400 24,400 1,000
Non-Current Residential Mortgages 50.0% 0 5,273 23,400 0 0
Other Non-Current Loans 150.0% 2,600 20,727 2,600 26,000 26,000
Securities 20.0% 70,000 70,000 70,000 70,000 70,000
Other Assets 100.0% 20,000 20,000 20,000 20,000 20,000
Total Assets $350,000 $350,000 $350,000 $350,000 $350,000
Risk-Weighted Assets $278,500 $286,455 $278,500 $290,200 $278,500
Non-Current / Total Loans 1.00% 10.00% 10.00% 10.00% 10.00%
56
Business Line Management
§ Basel III, with its new CET1 capital measure and new risk weights, will
require better allocations of capital to business lines and products to
achieve targeted returns
§ To evaluate capital allocations, one beginning point is to calculate the
return on capital deployed by product, business line, etc. Analysis is a
function of the following general inputs for a loan:
§ Rate on the loan
§ Funding costs for the portion of the loan not funded with equity
§ Any fees or other charges associated with the loan
§ Servicing costs, overhead, and the like
§ Potential credit losses
§ Taxes
§ The required capital allocated against the loan
Basel III Capital Rules Finally Final!
29!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
57
Business Line Management
§ Loan pricing becomes more critical under Basel III – this example assumes
a yield of 4.50% to produce an IRR of 12% on allocated capital assuming
the loan is 100% risk weighted
§ If the risk-weight rises to 150%, then IRR falls to 8.2%
§ Yield (price) would have to rise 100bps to 5.50% to offset the higher capital
allocation to restore the 12% IRR
Time PeriodAssumption 0 1 2 3 4 5
Interest Income 4.50% $225 $225 $225 $225 $225
- Interest Expense 1.00% (45) (45) (45) (45) (45)
- Servicing Costs 1.50% (75) (75) (75) (75) (75)= Pre-Tax Income $105 $105 $105 $105 $105
- Taxes 40.00% (42) (42) (42) (42) (42)= Net Income $63 $63 $63 $63 $63
Cash Flows ($525) $63 $63 $63 $63 $588Return on Allocated Capital 12.03%
58
Dividends
§ Regulators and Basel III require more and better planning, or these
creators of shareholder value may become less consistent and less
valuable to investors
§ Due to the capital conservation buffer, dividends as well as
discretionary bonuses may be more unpredictable after Basel III
§ As a potential future indicator of the greater difficulty in assessing a
bank’s ability to pay dividends, see the CCAR (for example SunTrust,
Fifth Third, and Citigroup) banks as an example
§ Some small banks have adopted a policy of a “regular” dividend and
annual “special” dividend dependent upon profitability (e.g., FFBC)
Basel III Capital Rules Finally Final!
30!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
59
Liquidity
§ Liquidity is part of capital planning
§ Basel III has a liquidity component, but it has not yet
been proposed by U.S. bank regulators
§ FASB Exposure Draft on Liquidity and Interest Rate Risk
Disclosures
§ Anticipating a higher, more normal interest rate
environment
60
REGULATORY MATERIALS & CITATIONS
SECTION THREE
Basel III Capital Rules Finally Final!
31!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
61
Capital Planning
§ Federal Reserve
§ SR 09-4 Applying Supervisory Guidance and Regulations on the
Payment of Dividends, Stock Redemptions and Stock Repurchases at
Bank Holding Companies (Rev’d. Mar. 27, 2009) plus FAQs,
Temporary Addendum and Attachments A and B
§ Comprehensive Capital Analysis and Review 2012: Methodology for
Stress Scenario Projections (Mar. 12, 2012) (“CCAR”)
§ CCAR FAQs (Mar. 21, 2012)
§ CCAR Q&A (Nov. 22, 2011)
§ Federal Reserve, “Capital Planning at Large Bank Holding Companies:
Supervisory Expectations and Range of Current Practice” (Aug. 2013)
62
Capital Planning
§ Tarullo, “Developing Tools for Dynamic Capital Supervision” (Apr. 10, 2012)
§ Tarullo, “The Evolution of Capital Regulation” (Nov. 9, 2011)
§ “Supervisory Guidance on Stress Testing for Banking Organizations With More Than
$10 Billion in Total Consolidated Assets” (May 17, 2012)
§ “Proposed Supervisory Guidance on Implementing Dodd-Frank Act Company-Run
Stress Tests for Banking Organizations with Total Consolidated Assets of more than
$10 Billion but Less than $50 Billion” (July 30, 2013)
§ “Interagency Proposed Supervisory Guidance on Implementing Dodd-Frank Act
Company-Run Stress Tests for Banking Organizations with Total Consolidated
Assets of More than $10 Billion but Less than $50 billion,” 78 F.R. 47217 (Aug. 5,
2013)
Basel III Capital Rules Finally Final!
32!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
63
Capital Planning
§ OCC
§ Guidance for Examining Capital Planning and Adequacy, OCC
2012-16 (June 7, 2012)
§ MacDonald, TARP and SBLF Repayments by Bank Holding Companies
(Dec. 2011) http://www.jonesday.com/tarp_and_sblf/
64
_________
CPE Code
Basel III Capital Rules Finally Final!
33!
August 29, 2013!
© 2013 Mercer Capital // Jones Day!
65
Questions?
Jeff K. Davis, CFA
615.345.0350
Andrew K. Gibbs, CFA, CPA/ABV
901.685.2120
Ralph (Chip) F. MacDonald, III
404.581.8622