Capital. It is first in the CAMELS (capital, assets, management capability, earnings, liquidity, and sensitivity) acronym and often first in many community bankers’ hearts. Its place of prominence within community bank balance sheets is due to how critical it can be to surviving problems created by asset quality, its neighbor in the acronym. Many community banks often carry excess levels of capital according to Wall Street’s standards, but that is because it sometimes may be harder to raise on Main Street when it is most needed. When a community bank has problems quickly selling its stock to interested shareholders, the bank’s best contingency plan for surviving a recession may be to pass the hat around the board table. Realizing this, prudent board members are often reluctant to test the lower boundaries of regulatory capital expectations.

One of the biggest problems community bankers had, until a few years ago, was determining exactly what those expectations were. Risk-based capital standards, which intended to adjust capital expectations relative to the riskiness of a bank’s assets supported by that capital, were often hard for community bankers to calculate and appreciate considering the complexity of the process for determining the denominators in the ratios and the numerous ratios tracked. For this reason, community bankers were thrilled a few years ago when the Community Bank Leverage Ratio (CBLR) was created by Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) of 2018.

The CBLR gave community banks a much simpler process for tracking capital expectations. Instead of having to track three or four separate capital ratios, community banks were allowed to track only one number, the bank’s leverage ratio, if they made an election on their call report and have total consolidated assets of less than $10 billion, off balance sheet exposures of 25% or less than total consolidated assets, and trading assets and liabilities of less than 5% of total consolidated assets. According to the legislation, that leverage ratio could be set anywhere between 8% and 10% by regulators through implementing legislation, who ultimately split the difference at 9%, save a brief period of time during the national COVID-19 emergency when the standard dropped to 8% pursuant to the Coronavirus Aid, Relief, and Economic Security Act (CARES). According to the original implementing regulations, if a community bank utilizing CBLR had a leverage ratio fall below 9%, it had two quarters to raise it back above 9% before being forced to revert back to the old, more complicated, standardized approach of capital measurement, so long as its leverage ratio never fell below 8%.

In April, federal banking regulatory agencies determined that their original CBLR bar was set too high and in a final rule lowered the minimum from 9% to the statutory minimum of 8%. Additionally, the grace period applied to community banks breaching that lower level was extended from two quarters to four, and community banks that move back above 8% within that four-quarter grace period are allowed to stay in the good graces of the CBLR so long as their leverage ratio never falls below 7%.

This is a significant change for many banks, and it frees up considerable community banking capital for growth. This is especially helpful for community banks that have a holding company with consolidated assets of less than $3 billion, since those institutions are allowed to utilize much more leverage at the holding company level and infuse more capital into their community banking subsidiaries whenever necessary.

This change has been championed by community bankers and is seen by most as an effective way to support lending within their localities. Those who survived 2008, though, may have a word of caution for their fellow bankers during this time of unusually good asset quality. When the second letter of the CAMELS acronym rears its ugly head, the first letter becomes much harder to find. Experienced board members know two things: Loan collateral appraisals can’t go up forever and be wary of the day the CEO brings his hat into the board room.

In April, federal banking regulatory agencies determined that their original CBLR bar was set too high and in a final rule lowered the minimum from 9% to the statutory minimum of 8%. Additionally, the grace period applied to community banks breaching that lower level was extended from two quarters to four, and community banks that move back above 8% within that four-quarter grace period are allowed to stay in the good graces of the CBLR so long as their leverage ratio never falls below 7%.

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