Banking Conditions, Regulatory Updates Discussed in New "ViewPoint"

September 30, 2019

By Michael Johnson, Executive Vice President
Supervision, Regulation, and Credit
Federal Reserve Bank of Atlanta

The third quarter has been as busy as usual. In addition to catching up on what I missed during my year at the Board of Governors in Washington, I had several opportunities to meet with folks from all over the Sixth District during conferences with community, regional, and large bank directors and officers that we were fortunate to host here at the Atlanta Fed. I always look forward to these events—it’s always beneficial to share perspectives with the industry and enhance the transparency of our supervisory programs and expectations. To that end, we begin, as always, with the State of the District.

State of the District
Overall, conditions in the Sixth District are stable in a very positive way. Only 4.6 percent of banks reported a net loss, the lowest level since the financial crisis. Compared with the prior year, earnings increased by 1 basis point to 1.4 percent, despite concerns about declining interest rates. However, an increasing number of banks reported a decline in their net interest margin, which bears watching considering the most recent cut in rates.

Median annualized asset growth for community banks in the Sixth District in the second quarter was 4.45 percent, the highest rate of growth in six quarters. Recently, however, bankers are reporting that economic uncertainty is affecting lending, as customers are electing to delay projects and lenders are rethinking their strategies to limit risk.

Asset quality at Sixth District banks remains strong. The median coverage ratio has grown to 1.7 percent, three times the level seen during the depths of the financial crisis. Liquidity is stable, with dependence on noncore funding remaining extremely low compared with historical levels. The median tier 1 common capital ratio for community banks in the Sixth District was 15.6 percent in the second quarter, basically unchanged from the prior year. At current levels, almost 99 percent of community banks in the District are considered well capitalized.

Although conditions in the District have been stable, it always pays to be aware of the broader economic environment. Recently, Fed governor Lael Brainard testified before Congress on financial stability. She noted that “business borrowing has risen more rapidly than GDP for much of the current expansion and now sits near its historical peak.” She added, “Analysis of detailed balance sheet information indicates that firms with high leverage, high interest expense ratios, and low earnings and cash holdings have been increasing their debt loads the most. Historically, high leverage has been linked to elevated financial distress and retrenchment by businesses in economic downturns.”

In addition to the corporate leverage concerns raised by Governor Brainard, we are focused as well on the earnings and potential pricing implications associated with the upcoming current expected credit loss (CECL) implementation as well as the pending transition away from the London Interbank Offered Rate, or LIBOR. Most firms appear to be moving in the right direction for CECL implementation, and we will be closely monitoring progress. In contrast, many institutions still have a long way to go to prepare for the transition away from LIBOR—2021 will arrive before we know it! Stay tuned for more information—this quarter’s edition of “ViewPoint” will feature an article on preparing for the sunset of LIBOR.

Regulatory update
On the regulatory front, the banking agencies continue to move forward with implementation of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), and remain focused on tailoring supervisory expectations based on risk.

A final rule about the Volcker Rule exemption for community banks
In July, a final rule to exclude community banks from the Volcker Rule, consistent with requirements of the EGRRCPA, was adopted by five federal regulatory agencies, including the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC). Under the final rule, community banks with $10 billion or less in total consolidated assets and total trading assets and liabilities of 5 percent or less of total consolidated assets are excluded from the Volcker Rule. The rule also allows a hedge fund or private equity fund, under certain circumstances, to share the same name or a variation of the same name with an investment adviser as long as the adviser is not an insured depository institution, a company that controls an insured depository institution, or a bank holding company.

A final rule on capital simplification
On July 9, the federal bank regulatory agencies issued a final rule to simplify and clarify a number of the more complex aspects of the agencies' existing regulatory capital rules. The simplifications apply to banking organizations that do not use the "advanced approaches" capital framework. Those organizations are generally firms with less than $250 billion in total consolidated assets and less than $10 billion in total foreign exposure.

The rule simplifies the capital treatment for mortgage-servicing assets, certain deferred tax assets, investments in the capital instruments of unconsolidated financial institutions, and minority interest. The final rule also would allow bank holding companies and savings and loan holding companies to redeem common stock without prior approval unless otherwise required. Proposed revisions to the definition of high-volatility commercial real estate exposure are being addressed in a separate rulemaking.

The final rule will be effective as of April 1, 2020, for the amendments to simplify capital rules, and as of October 1, 2019, for revisions to the preapproval requirements for the redemption of common stock and other technical amendments.

A proposed rule for the capital treatment of land development loans
Also in July, the agencies proposed a rule to clarify the capital treatment of land development loans. The land development proposal would clarify that loans that solely finance the development of land for residential properties would meet the revised definition of high-volatility commercial real estate, commonly known as HVCRE, unless the loan qualifies for another exemption. The rule would apply to all banking organizations subject to the agencies' capital rules.

An interagency statement on Bank Secrecy Act/anti-money laundering supervision transparency
On July 22, 2019, an interagency working group, formed by several financial supervisory agencies and Treasury's Office of Terrorism and Financial Intelligence, released a statement on their risk-focused approach to Bank Secrecy Act (BSA)/anti-money laundering (AML) supervision. The risk-focused approach enables federal agencies to better tailor examination plans and procedures based on the unique risk profile of each bank. Using this approach, the agencies generally are able to allocate more resources to higher-risk areas and fewer resources to lower-risk areas.

An update on the Community Bank Leverage Ratio (CBLR)
On September 17, the FDIC finalized rules to simplify the capital calculation for qualifying community banks, as required by EGRRCPA. The Board of Governors and the OCC are expected to follow suit in the near future. The CBLR framework will be available for banks to use in their March 31, 2020, Call Report.

As always, we welcome your comments or questions. Please share your feedback at Remember to check back here for the upcoming LIBOR transition article, among other articles, that “ViewPoint” will publish in the coming quarter.

photo of Michael Johnson
Michael E. Johnson

Executive Vice President, Supervision & Regulation
The Federal Reserve Bank of Atlanta