Simplified Community Bank Capital Calculation Hits DTAs

By Trudie D. Kanter, CPA, and Kevin F. Powers, CPA
| 3/12/2019
Proposed guidance on an elective community bank leverage ratio (CBLR) framework would provide for a simple measure of capital adequacy for certain qualifying banks – but those banks ultimately could find the new framework punitive because of the deferred tax impact. 

The Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency recently issued a proposed guidance that would allow qualifying community banks with less than $10 billion in total consolidated assets to elect the framework to calculate a simpler capital ratio compared to the existing risk-based and leverage capital requirements. Banks with certain deferred tax assets (DTAs), however, would likely face a larger cut on their regulatory capital.
 
Overview of the CBLR framework
On Feb. 8, 2019, the regulators published a notice of proposed rulemaking, “Regulatory Capital Rule: Capital Simplification for Qualifying Community Banking Organizations.” The notice stems from Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (the act), passed in May 2018. The act directed the federal banking agencies to promulgate a rule establishing a new CBLR of 8 to 10 percent for qualifying community banking organizations with less than $10 billion in total consolidated assets. 

The proposed guidance outlines a new elective framework intended to relieve the burden of regulatory compliance by simplifying the measurement of capital adequacy for qualifying community banking organizations. A qualifying community banking organization can opt into the CBLR framework if its CBLR is greater than 9 percent.

A community bank generally qualifies if it has all of the following:
  • Total consolidated assets of less than $10 billion
  • Total off-balance sheet exposures (excluding derivatives other than credit derivatives and unconditionally cancelable commitments) of 25 percent or less of total consolidated assets
  • Total trading assets and trading liabilities of 5 percent or less of total consolidated assets
  • Mortgage servicing assets (MSAs) of 25 percent or less of CBLR tangible equity
  • Temporary DTAs, net of any related allowances, of 25 percent or less of CBLR tangible equity
The proposed calculation of the CBLR
The proposed guidance would compute the CBLR as the ratio of CBLR tangible equity divided by average total consolidated assets.

CBLR tangible equity would be calculated as the total bank equity capital (or total holding company equity capital), determined according to the reporting instructions to Schedule RC of the call report (or Schedule HC of Form FR Y-9C), prior to including minority interests, less the following:
  • Accumulated other comprehensive income (AOCI)
  • All intangible assets other than MSAs (for example, goodwill and core deposit intangibles)
  • DTAs, net of any related valuation allowances, that arise from net operating loss (NOL) and tax credit carryforwards, each as of the end of the most recent calendar quarter
CBLR tangible equity would not include minority interests (equity of a consolidated subsidiary that is not owned by the qualifying community banking organization).

Specifically, average total consolidated assets for purposes of the CBLR denominator would be calculated according to the reporting instructions to Schedule RC-K on the call report (or Schedule HC-K on Form FR Y-9C), as applicable, less the items deducted from the CBLR numerator, except AOCI.

Critical changes to deferred taxes
The proposed framework seems like welcome news at first glance, but, unlike the current rule, it would not allow the option for netting deferred tax liabilities (DTLs) before reducing the CBLR tangible equity numerator. This change would have a negative impact on community banks with significant DTAs related to NOL and tax credit carryforwards. These organizations would end up with lower regulatory capital than they do under the existing method.
 
Proposed guidance's effect on deferred taxes
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Proceed with caution
If adopted by the regulators as currently drafted, the CBLR framework will be elective. Community banks considering the election should bear in mind the tax implications, especially those related to DTAs. For banks with significant DTAs on NOL and tax credit carryforwards, the new framework appears to be more punitive than the current approach due to the inability to reduce their DTAs by DTLs. 

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