Alert September 28, 2010

OTS Updates Examination Handbook Section on Capital Adequacy

The OTS issued an updated Examination Handbook Section on Capital Adequacy (“New Section 120”), providing extensive revisions from the previous version.  Changes include, among other things, (1) an expanded discussion on assessing compliance with minimum regulatory capital requirements, and (2) updates on the Basel International Accord.  New Section 120 also significantly expands the discussion on assessing overall capital adequacy to include: (a) a review of an institution’s own capital adequacy assessment process; (b) factors that affect capital, including material risks; (c) an assessment of the quality of capital; and (d) an assessment of capital adequacy relative to an institution’s unique risk profile.

The OTS also revised the appendices to New Section 120, incorporating the contents of former Appendix A: Capital Components and Risk-Based Capital, and former Appendix B: Supplementary Information and Issues, with updates into two new appendices: Appendix A, which focuses on the components of capital (Tier 1, Tier 2 and total capital); and Appendix B, which focuses on the calculation of risk weighted assets.  Updates provided in these appendices include, among other things: (i) a discussion on the regulatory capital treatment of TARP and CPP payments; (ii) an updated discussion on the importance of common stockholders equity as the predominant form of Tier 1 capital, and an expanded discussion on the composition of common stockholders’ equity and noncumulative perpetual preferred stock; (iii) an updated discussion of regulatory policy with regard to accounting changes affecting the treatment of on- and off-balance sheet assets; and (iv) a discussion about underwriting and qualifying residential mortgage loans for the fifty percent risk-weight category.

In addition, the OTS retained Appendix C, Prompt Corrective Action Restrictions with no changes and added a new Appendix D addressing frequently asked questions and answers regarding the risk weight treatment of various types of one-to-four family residential mortgage loans.