Monthly LRA Update

REGULATORY DEVELOPMENTS

Basel III Endgame Comment Submissions

The comment period for the proposed capital rules (commonly referred to as Basel III Endgame) concluded on January 16. Hundreds of comment letters were submitted with thousands of pages of views expressed. Comment letters can be reviewed at both the FDIC and Regulations.gov websites. We have reviewed many of the comments to identify aspects that are relevant to BOLI programs.

Bank Policy Institute (BPI) and American Bankers Association (ABA)

These industry trade groups submitted a 314-page joint letter commenting on various aspects of the proposal. We noted the following observations relevant to our readers:

• The Full Look-Through Approach should not be required for Separate Account BOLI; use of the Alternative Modified Look-Through should remain permissible (PDF page 110);
• The requirement that a fund’s financial information be verified by a third party on a quarterly basis to use the Full Look-Through Approach should not be adopted (PDF page 111);
• With respect to the Alternative Modified Look-Through approach, a bank should be able to calculate RWA amounts for derivatives and securitizations based on actual volumes of these exposures (PDF page 112);
• BOLI/COLI Separate Accounts should not be “market risk covered positions” (PDF page 116);
• Hedges related to deferred compensation plan obligations should be eligible for either “banking book” or “trading book” rules (PDF page 118); and
• The comment letter also addressed views on the appropriateness of various risk weights and methodologies for underlying exposures.

SIFMA and ISDA

These industry trade groups submitted a 168-page joint letter commenting on various aspects of the proposal. With respect to BOLI-related topics, both observations were consistent with (or referenced in) the BPI and ABA letter.

• BOLI/COLI should be specifically excluded from market risk capital requirements (PDF page 71); and
• Banking organizations should be permitted to treat equity positions arising from employee compensation plans and related hedges as market risk covered positions, thereby allowing a bank to treat both the position and the hedge as market risk covered positions to reflect a more risk-sensitive approach by allowing for appropriate recognition of the hedge under FRTB (PDF page 72).

Finseca

Finseca submitted a comment letter focused on the treatment of mutual life insurance companies and BOLI exposures to such companies relative to publicly traded insurers. Of primary emphasis was to avoid a situation where a mutual insurer could be subjected to higher risk weights (e.g., 100% versus 65%) simply because it did not have publicly traded securities.

Mutual Insurers

Guardian, MassMutual, Nationwide, New York Life, Northwestern, Securian, TruStage, and Western & Southern submitted a joint comment letter also advocating against a risk weight being affected by not having publicly traded securities. They recommended corporate exposures to all investment grade insurers receive a reduced risk weight that is no higher than 65%.

New York Life

In addition to participating in the joint comment letter with other mutual insurers, New York Life submitted its own comment letter. It was also focused on the proposed requirement to have publicly issued securities to qualify for a 65% risk weight. New York Life provided data showing its credit ratings over time relative to other insurers (including stock-based insurers) and emphasizing its overall financial strength.

In addition to recommending removal of the distinction for publicly traded securities, New York Life suggested that the final rule should “…provide a healthy incentive for banks to select the strongest BOLI issuers in the marketplace.”

Newport

Newport, a provider of insurance services relative to BOLI (including design, implementation, and administration), submitted an independent comment letter.

Newport’s letter addressed the following topics:

• Mutual insurers should not be subjected to (potentially) higher risk weights than publicly traded insurers;
• Clarification on Separate Account BOLI Look-Through Approaches;
• Risk-weighting of BOLI that hedges a Deferred Compensation Plan; and
• Whether it might be appropriate to further reduce the risk weights for BOLI.

Regarding Separate Account BOLI Look-Through approaches, Newport is requesting clarification on if the proposal’s revised rules for investment fund exposures will apply to BOLI Separate Account exposures. Assuming it applies, Newport requested that the prescribed “Hierarchy of Look-Through Approaches” not apply and that the Alternative Modified Look-Through approach remain available.

Regarding BOLI used to hedge a deferred compensation plan, Newport’s commentary was broadly consistent with the trade associations in advocating for either the continuation of a “non-significant equity exposure” treatment or the ability to recognize the financial offset of the plan liabilities (i.e., risk weight the net asset exposure).

Finally, Newport suggested that General Account BOLI may merit lower risk weights (less than 100% under standardized and 65% under the proposed ERBA), and Separate Account

BOLI should not be subject to a 20% floor (especially if a bank uses the Full Look-Through Approach).

Category III Banks

Capital One, PNC, Truist, and U.S. Bank submitted a 49-page joint comment letter addressing various topics under the proposal.

Related to BOLI, the following observations were submitted:

• Advocated against the elimination of the 100% risk weight for non-significant equity exposures, noting that certain benefit plans (including qualified and non-qualified plans) are overfunded and could become subjected to more punitive risk weights (PDF page 44);
• Requested clarification that BOLI/COLI separate accounts would be exempt from being treated as market risk covered positions (PDF page 45); and
• The proposed rule should not mandate the use of a Full Look-Through Approach for equity exposures to investment funds (over the Alternative Modified Look-Through Approach).

With respect to the Look-Through Approaches, the banks noted:

The full look-through approach, although undoubtedly more granular than the alternative modified look-through approach, is also more burdensome and time-consuming, particularly for investments in funds sponsored and managed by third parties. As the alternative modified look-through approach cannot produce RWAs that are lower than those produced under the full look-through approach, the Banks respectfully submit that there is no reason to obligate banking organizations to use the full look-through approach if they are willing to accept the trade-off of the less burdensome, but more conservative, alternative modified look-through approach.

ACCOUNTING DEVELOPMENTS

Midland States Bank BOLI Accounting Adjustment

In its fourth quarter earnings release (issued January 25), Midland States Bank disclosed a revision of its accounting related to the surrender and purchase of BOLI policies in the third quarter of 2023.

In the third quarter, the bank had disclosed that it restructured BOLI and recognized losses on the sale of investment securities. In conjunction with the BOLI restructuring, the bank recorded a non-recurring “enhancement fee” of $6.6 million in its non-interest income.

In the fourth quarter earnings release, the bank announced that it reversed the recognition of the $6.6 million enhancement fee. The earnings release did not provide a specific reason for the revision.

Here is an excerpt from the bank’s 4th quarter press release:

The Company revised its accounting for the one-time enhancement fee related to the surrender and purchase of company-owned life insurance policies acquired in the third quarter of 2023. As a result, the $6.6 million enhancement fee on the replacement policies that was previously recorded in income on company-owned life insurance in the third quarter of 2023 has been reversed. The revision did not have an impact on adjusted earnings (a non-GAAP financial measure) for that period. The Company reflected this revision in its September 30, 2023 quarter to date and December 31, 2023 year to date income on company-owned life insurance. Additionally, the revision impacts the company-owned life insurance asset for the applicable period.

We reviewed the BOLI balances originally reported in the third quarter and confirmed that they were $6.6 million greater than the restated Q3 values.

Kearny Bank BOLI Accounting Adjustment

On January 31 Kearny Bank released a revision to its fiscal Q2-2024 results which were originally issued a week earlier. The revision announced an adjustment to the timing of income recognition associated with a $4.8 million non-recurring increase in cash surrender value (the “enhancement fee”) associated with restructuring its BOLI portfolio. The enhancement fee was originally recognized as non-interest income during the quarter.

The revision included the following explanation:

During the quarter ended December 31, 2023, the Company recorded a $4.8 million non-recurring increase in BOLI cash surrender value and recognized the enhancement fee within non-interest income. Subsequent to the issuance of the Original Earnings Release, the Company continued to evaluate the matter and determined it was necessary to revise its accounting for the enhancement fee and derecognize the enhancement fee and the increase in BOLI cash surrender value initially recorded in the financial statements as of and for the quarter ended December 31, 2023. As a result, the $4.8 million enhancement fee will be recognized prospectively as non-interest income in future periods.

The press release reiterated that Kearny initiated a restructuring of $103.4 million of BOLI yielding 2.1% for new policies yielding 5.1%. As a result, the bank recognized $5.7 million of tax expense and ~$600k of exchange charges.

From prior earnings releases, we are aware of a few other banks that reported similar BOLI restructuring transactions and enhancements to those of Midland States and Kearny. We will continue to monitor to see if additional revisions are announced and if more information becomes available regarding the reasons for the adjustments.