PRICING HIGHLY VOLATILE CRE LOANSUNDER BASEL III GUIDELINES

Proposed regulatory standards.... increased capital requirements…..revised risk

weights….…lower returns….….product profitability recalibrated…….Risk Adjusted Return On Capital

(RAROC)

§ Implements a new capital measure – CommonEquity Tier I Capital (CET1)

§Raises the Minimum Standards for all other Capital Measures to be considered Well Capitalized

§Allows for Accumulated Other Comprehensive Income (AOCI) to be considered as Capital

§Causes substantial reductions to “Excess Capital” at most institutions currently considered well capitalized

PROPSEDREGULATIONBasel III NPR – Summary of Major Provisions

§Defines Highly Volatile Commercial Real Estate Loans (HVCRE) – All Acquisition, Construction & Development Loans (ACD) – and CRE Loans with LTV ratio above supervisory guidelines

§For 1-4 Family Residential Mortgage Loans –creates Category 1 & 2 risk categories – with generally higher risk weightings based on LTV ratios (35%, 50%, 75%, 100%, 150%, 200%)

§Establishes higher risk weights for past due loans (generally 150%)

PROPSEDREGULATIONBasel III NPR – Summary of Major Provisions

EXAMPLE IMPACTS TO EXCESS CAPITALA $600 M ASSET COMMERCIAL BANK - $70 M of Capital

Before (Minimum) After (CCB*)

Leverage Ratio 8.36% (5.0%) 8.65% (5.0%)

Tier I Capital Ratio 10.89% (6.0%) 9.88% (8.5%)

Total Capital Ratio 12.14% (10%) 11.13% (10.5%)

NEWCommon Equity Tier 1 Ratio N/A 9.88% (7.0%)

* Capital Conservation Buffer

EXAMPLE IMPACTS TO EXCESS CAPITALA $600 M ASSET COMMERCIAL BANK - $70 M of Capital

Assumptions:

Ø Percentage of Commercial Loans determined to be HVCRE - 15%Ø Percentage of Mortgage Loans determined to be Category 2 - 10%

q Category 1 Loans by LTV %§ LTV% < 60% 40%§ LTV 60 – 80% 15%§ LTV 80 – 90% 10%§ LTV > 90% 35%

q Category 2 Loans by LTV %

§ LTV < 80% 45%§ LTV 80 – 90% 10%§ LTV > 90% 45%

EXAMPLE IMPACTS TO EXCESS CAPITALA $600 M ASSET COMMERCIAL BANK - $70 M of Capital

Before (Minimum) After (CCB*)

Calculation of “Excess Capital” Tier I Capital % Tier I Capital %

Actual @ 10.89% / 9.88% $51.2 M $53.1 M

Minimum @ 6.0% / 8.5% $28.2 M $45.7 M

Excess Capital $23.0 M $ 7.4 M

Decrease $15.6 M

* Capital Conservation Buffer

EXAMPLE IMPACTS TO EXCESS CAPITALA $600 M ASSET COMMERCIAL BANK - $70 M of Capital

Where did the Capital Go?

Increase in Minimum Standard from 6% - 8.5% $11.8 M

Increase in Risk Weighting of Assets $ 4.0 M

Increase in Capital Due to Addition of AOCI ($ 0.2) M

Total Decrease in Capital Due to Basel III $15.6 M

CASESTUDYBASEL III IMPACT ON LOAN PRICING

Commercial Real Estate Loan§ Loan Amount: $500,000

§ Loan Rate: 4.00%

§ Loan Term: 60 months

§ Credit Quality: Average

§ Capital Allocation: 9.00% (100% Risk Weighted)

CASESTUDYBASEL III IMPACT ON LOAN PRICING

Annual Profit

CASESTUDYBASEL III IMPACT ON LOAN PRICING

CASESTUDYBASEL III IMPACT ON LOAN PRICING

Highly Volatile CRE Loan§ Loan Amount: $500,000

§ Loan Rate: 4.00%

§ Loan Term: 60 months

§ Credit Quality: Average

§ Capital Allocation: 13.50% (150% Risk Weighted)

CASESTUDYBASEL III IMPACT ON LOAN PRICING

Annual Profit

CASESTUDYBASEL III IMPACT ON LOAN PRICING

CASESTUDYBASEL III IMPACT ON LOAN PRICING

Alternative Risk Adjustment Factors§ Loan to Value ratio

§ Debt Service Coverage ratio

§ Collateral types

CASESTUDYBASEL III IMPACT ON CAPITAL PLANNING AND STRESS TESTING

Example Institution§ Asset Size: $215M

§ Loan Portfolio: $150M

§ 1-4 Family RE: $50M (50% Risk Weighted)

§ Commercial RE: $75M (100% Risk Weighted)

§Other Loans: $25M (100% Risk Weighted)

§ Total Risk Weighted Loans: $125M

CASESTUDYBASEL III IMPACT ON CAPITAL PLANNING AND STRESS TESTING

Example 3 Year Plan§Modest Loan Growth: 3%

§ Bank maintains comfortable capital cushion over their established targets

CASESTUDYBASEL III IMPACT ON CAPITAL PLANNING AND STRESS TESTING

Proposed Guidelines

CASESTUDYBASEL III IMPACT ON CAPITAL PLANNING AND STRESS TESTING

Example Institution§ Asset Size: $215M

§ Loan Portfolio: $150M

§ 1-4 Family RE: $50M (various Risk Weightings)

§ Commercial RE: $75M (various Risk Weightings)

§Other Loans: $25M (100% Risk Weighted)

§ Total Risk Weighted Loans: $166.5M

CASESTUDYBASEL III IMPACT ON CAPITAL PLANNING AND STRESS TESTING

Example 3 Year Plan§Modest Loan Growth: 3%

§ New risk weightings applied

§ Bank falls below its established targets

STRATEGIES / NEXTSTEPS

• Adjust product design / offerings as needed

• Adjust pricing policies necessary to move balances / adjust returns

• Determine additional capital requirements

• Analyze degree of product mix change necessary / possible / desired

• Forecast financial implications of product mix changes expected

• Identify current levels of HVCRE and Mortgage Loans with Risk Weights above 50% (current level)

• Recalibrate Capital Allocation Model

• Calculate impact on product profitability in ROE terms

PREPARE

EXECUTE

PLAN

HOW CAN WE HELP?Austin Associates, LLC

Support / Services§ Formal Independent Third Party Review of

In-house Systems (Profitability, Loan Pricing, ALCO)§ Informal Review / Recommendations of In-

house Systems (Profitability, Loan Pricing)§Operating Cost / Efficiency Reviews and

Recommendations§ Branch Network Analysis

Software§ Capital Planning System (CAPS Model)§ Loan Pricing System (LPS)§ Deposit Pricing Module (DPM)§ Customer Profitability Reporting System

(CPRS)

ADDITIONALRESOURCES

For more information please visit our website:

www.austinassociates.com

THANK YOUFOR ATTENDING

CONTACTUSYOUR PRESENTERS

419.841.8521

Jeffrey L. MorrisManaging Director & PrincipalFinancial Management Division

jmorris@austinassociates.com

Andy E. MorganManaging Director & PrincipalFinancial Management Division

amorgan@austinassociates.com