A lot of things in banking are coming back around, including an old capital measure that is regaining popularity — risk-based capital.
Examiners are especially interested in risk-based capital levels as of late, some community bankers say. That renewed focus could have a big impact if, as many industry officials expect, minimum requirements rise.
"What we've seen is that the key ratios that the regulator is looking at is risk-based capital," Astoria Financial Corp. Chief Executive Monte Redman said at a recent Sterne, Agee & Leach Inc. investor conference. "When you take a look at stress testing, you're talking about risk-based capital. [Regulators] want risk-based capital to be there and to enforce any problems you may have."
In the early years of the financial crisis, when the Troubled Asset Relief Program was underway, regulators favored tangible common equity as the truest measure of a bank's health. The ratio compares tangible common equity to total assets, and it is said to show how strong a bank's first lines of defense are without complicating factors like goodwill or deferred tax assets. At other times, experts have stressed leverage ratios.
The two principal risk-based capital ratios divide either total or Tier 1 risk-based capital by total assets. They let regulators put the greatest risk weight on lending, while deemphasizing cash and securities, Jim Basey, the chief executive of Centennial Bank in Denver, said in an interview. It's also an easier ratio to calculate than some others, he said.
But an emphasis on risk-based capital forces bankers to put assets in places, like Treasury bonds, that currently provide little return.
The focus appears to range from the biggest community banks, like $17 billion-asset Astoria, to the smallest, such as $148 million-asset Centennial Bank in Denver.
"They really are stressing the risk-based capital ratios," Basey said. "We've had some failures in Colorado and it seems like whenever a supervisory action takes place on any of those banks, they always stress the improvement of the risk-based capital ratio."
Risk-based capital is frequently cited by regulators when examining troubled banks, said Jones Day banking lawyer Chip MacDonald.
"You see it all the time in enforcement actions," MacDonald said. "Regulators will evaluate the risk of a portfolio, and say, 'You should have more capital.'"
The Federal Deposit Insurance Corp. denies that anything has changed.
"For a long time U.S. banks have needed to comply with both leverage and risk-based requirements," said David Barr, an FDIC spokesman. "This has not changed, and there are no plans to do so."
The current minimum ratios for banks to be considered well capitalized are 10% for total risk-based capital, and 6% for Tier 1 risk-based capital. But many expect those levels to increase as a result of the Basel III rules, said Chris Cole, senior regulatory counsel for the Independent Community Bankers of America.
"Both total risk-based capital and Tier 1 could possibly rise," Cole said.
Though the official minimums may be 6% and 10% to be considered well capitalized, Cole said that those ratios are not uniformly enforced.
"You don't know how many calls I've gotten from community bankers across the country saying, 'They're requiring us to have 12% total risk-based capital, or even as high as 14% in California or Florida," Cole said.
"The examiner always has the power to say, 'I don't care what the minimums are by regulation. You need to have this level of capital because of your risk profile," Cole said.
Some think the focus on risk will have less impact on banks with less than $500 million of assets.
"Smaller banks will normally hold capital well in excess of the risk-based capital standards to begin with," said Baldwin-Wallace College finance professor Kevin Jacques, a former Treasury Department economist. "It's not that those institutions are not important, but they've got higher capital ratios and resolving those institutions is typically less costly."
Both Astoria and Centennial have plenty of capital. Centennial's total risk-based capital ratio was 17.84% on Dec. 31, and its Tier 1 risk-based was 16.77%. Astoria, the holding company for the thrift Astoria Federal Savings & Loan, reported a total risk-based capital ratio of 16.08% on Dec. 31, and a Tier 1 risk-based capital ratio of 14.8%. Astoria, of Lake Success, N.Y., did not respond to requests for additional comments from Redman.
Risk-based capital levels can vary widely at community banks. Apple Financial Holdings Inc., a $7.6 billion-asset company in Manhasset, N.Y., had a Tier 1 risk-based capital ratio of 26.9% at yearend. At the other end of the spectrum, Johnson Financial Group Inc., a $4.1 billion-asset bank in Racine, Wisc., had Tier 1 risk-based capital at year end was 2.8%.
"Looking at risk makes more sense," Basey said. "We sit as lenders to business, and we want to know what risk our borrowers have on their balance sheets. So why wouldn't regulators want to know the same thing about banks?"