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August 2012
CET1 includes common equity as defined under GAAP and does not include any other type of noncommon equity under GAAP. It also includes a number of adjustments - many of these are consistent with adjustments under the current rules. However, other adjustments are new.
Non-Cumulative Perpetual Preferred Stock, SBLF Preferred, and TARP Preferred are included in Additional Tier 1 Capital. Sub Debt, TRUPS, and Cumulative Preferred are now only included in Tier 2 Capital since they do not meet the definition of equity under GAAP.
If firms do not meet these minimum capital ratios, they will be limited in regards to dividends, share repurchases, and significant discretionary bonuses. While the Capital Conservation Buffer does not impact the Leverage ratio, firms are still required to maintain a 5.00% Leverage ratio in order to be well-capitalized.
Tier 2 Capital
AOCI
Under Basel III, AOCI is typically included in regulatory capital except for unrealized net gains and losses from cash flow hedges.
In other words, a net cash flow gain would be deducted from CET1 while a net cash flow loss would be added to CET1. This applies to all situations including those in which the hedge is used for an AFS investment.
As a result of this, the cash flow hedge will be excluded from CET1 while the mark-to-market on the AFS investment will be included in CET1.
DTAs
Under Basel III, any DTAs related to Operating Losses and Tax Credit Carry forwards, including those that were acquired via an acquisition, will be deducted from CET1 due to the uncertainty of a firm to be able to recognize the value.
(A struggling bank unable to generate income is unlikely to realize these benefits at the time that it most needs them in order to maintain adequate capital levels).
However, banks are allowed to include temporary differences (up to a certain limit) that are unrelated to operating losses or tax credit carry forwards since these typically have value regardless of the profitability of a firm. These DTAs are subject to the individual and aggregate threshold limits.
Individual Deduction
The Basel III Individual Deduction applies to the following three balances: DTAs unrelated to operating losses or tax credit carry forwards Mortgage Servicing Assets (MSAs)
Common stock unconsolidated investments where the bank owns 10% or more of the common stock of the other firm.
For each of these individual items, a bank is required to deduct from CET1 any individual amount that exceeds 10% of the bank's CET1 capital prior to the Individual or Aggregate Deduction
Aggregate Deduction
The Basel III Aggregate Deduction is a deduction used to limit the aggregate amount of the three individual balances from the Individual Deduction that can count towards CET1 to 15% of the CET1 AFTER this adjustment is applied. In addition, the Individual Deductions related to MSAs and the Aggregate Deduction combined must be equal to or greater than 10% of the fair market value of the MSAs.
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Basel III requires 1-4 Family Loans to be separated into two categories before applying the risk weight. Generally speaking, Category 1 loans are 1-4 Family First Lien loans that meet all of the following criteria:
Fully amortizing with no balloon Have term less than or equal to 30 years
Category 2 loans are 1-4 Family First Lien loans that do not meet the definition of Category 1 AND 1-4 Family Jr. Lien and Home Equity Loans.
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For Category 2 loans under Basel III, the risk weight by LTV is as follows: <80% = 100% risk weight 80 to 90% = 150% >90% = 200%
The "Loan" amount in LTV is equal to the current unpaid principal balance. The "Value" in LTV is equal to the lesser of the A) actual acquisition cost of the property or B) the estimate of property's value at origination of loan or at time of restructuring or modification. The LTV for purposes of Basel III does not include or recognize Private Mortgage Insurance.
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Key Contacts
John Montgomery Director of Financial Institutions 434-951-7669 jmontgomery@snl.com HD Jacobs Product Expert 434-951-7710 hjacobs@snl.com Julie Jones Business Development Manager 434-951-4419 jjones@snl.com
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