Basel III - Are Your Unfunded Commitments Unconditionally Cancellable?

Determining whether your lines of credit are considered "unconditionally cancellable" could mean the difference between a zero percent credit conversion factor and a 20 to 50 percent credit conversion factor on your unfunded commitments.

According to the Code of Federal Regulations (download available here) "unconditionally cancellable "means that the bank may, at any time, with or without cause, refuse to advance funds or extend credit under the facility. The bank is deemed able to unconditionally cancel the commitment if it can, at its option, prohibit additional extensions of credit, reduce the line, and terminate the commitment to the full extent permitted by relevant Federal law.

The regulations further clarify that commitments qualify for the zero percent conversion factor if they are unconditionally cancellable and the bank has the contractual right to make: (a) a separate credit decision based upon the borrower's current financial condition, before each drawing under the lending facility; or (b) an annual (or more frequent) credit review based on the borrower's current financial condition to determine whether the lending facility should be continued.

Refer to the terms set forth in your promissory notes and loan agreements. Language such as "you may refuse to make a loan to me under this line of credit once the aggregate outstanding advances equal or exceed zero" may indicate that your agreement is discretionary and therefore unconditionally cancellable. If your loan terms are not clearly defined, we advise seeking legal counsel to determine if your commitments meet the criteria of unconditionally cancellable.

Don't Forget About the Opt-out Election 

Management should coordinate with the board of directors as to whether the bank will choose to "opt-out" of the accumulated other comprehensive income inclusion in regulatory capital. This important, one-time election to be made in the March 31, 2015, call report should be a board-directed election. We suspect most, if not all, community banks will choose to opt-out of the inclusion.

Further materials regarding Basel III and the impact to your capital can be found in our February 2015 issue of Possibilities for Financial Institutions, available for download here.

For further information, please contact your local Eide Bailly professional.