Content by HUB|Taylor Advisors, a WBA Associate Member
By Todd Taylor, CFA, CPA and Tom Evans, CFA
We have published a series of articles about getting your liquidity and interest rate risk management processes exam ready. As we talk to various clients and present at numerous events, it is becoming clear that capital is shifting into focus for all regulatory agencies. Early on in the pandemic, fiscal and monetary stimulus flooded balance sheets with low-cost deposits, oftentimes creating asset growth that exceeded capital generation. Regulators were quick to provide a grace period for leverage ratios in response to the emergency programs as liquidity was bountiful and risk-based capital ratios were contained. In this article, we’ll set the stage for what examiners are focusing on, and how you can prepare for more scrutiny around credit concentrations and capital management.
Regulators have a long-standing scrutiny of commercial real estate (CRE) and Acquisition/Construction and Development (C&D) concentrations dating back to pre-crisis times. Numerous FILs, publications, and advisories have been issued to document expectations around monitoring these concentrations and best practices for ongoing management. We are beginning to see regulators take a more ‘proactive’ approach to supervising institutions with lower key capital ratios and higher concentrations and growth rates.
- The OCC is increasingly implementing Individual Minimum Capital Ratios (IMCR) to address CRE and concentration concerns, implementing minimum ratios of 9-10% for Tier 1 Leverage and 12-14% for Total Risk-Based Capital.
- Other regulators are engaging in CRE enforcement actions (formal and informal) directing banks to reduce CRE concentrations and enhance portfolio monitoring and reporting.
- Merger approvals are increasingly incorporating CRE concentrations and capital levels, with some recent deals announced in conjunction with capital raises.
As we have written before, there is a strong relationship between credit cycles and interest rates. While the banking sector has not seen materially adverse credit losses, we have seen consumer delinquencies return to and exceed pre-pandemic levels. Additionally, the CMBS market is showing refinancing challenges for low coupon underperforming office and multifamily loans as delinquency and default rates are gaining momentum.
In response to enhanced scrutiny of capital, institutions are evaluating avenues to shore up capital via subordinated debt, a holding company loan or line of credit, sale-leaseback, and mutual holding company conversions, to name a few. Each of these sources comes with varying costs of capital but can help to fortify the balance sheet for potential turbulence down the road. Other institutions are evaluating investment loss trades to reposition balance sheets, giving up regulatory capital today for potential longer-term benefits. Depending on your institution’s capital levels and concentrations, now may not be the optimal time to deplete regulatory capital for a protracted break-even prospect.
Taylor Advisors Take: A bird in the hand may be worth two in the bush! Institutions must be preparing today for heightened capital and regulatory risk tomorrow. Risks and opportunities are unique to each institution based on their respective loan portfolio, capital, liquidity, interest rate risk, and investment portfolio. An effective ALCO from a whole balance sheet perspective can help ensure that your entire balance sheet is ready for the next exam, for the next phase of the credit and interest rate cycle, and to implement tailored strategies to set your institution up for long-term success.
An Associate Member of WBA, HUB|Taylor Advisors provides consulting and advisory services in the areas of ALCO, capital, liquidity, interest rate risk, and investments to community-based financial institutions throughout the country. To learn more, visit www.tayloradvisor.com or contact Todd Taylor at todd.taylor@hubinternational.com and Tom Evans at tom.evans@hubinternational.com.
