Capital Savior Flashcards
What is the purpose of Capital?
1- Absorb losses
2- Promote Public Confidence
3- Restrict Excessive Asset Growth
4- Provide Protection to Depositors and the FDIC insurance Fund
How do you calculate Tier 1 Capital?
- Common stockholders’ equity (common stock, surplus, UP, disclosed capital reserves that represent a segregation of UP, and foreign currency translation adjustments, less net unrealized losses on AFS equity securities)** Remember that debt securities unrealized gains/losses and cash flow hedge gains/losses do not impact tier one capital and should be removed.
- Noncumulative perpetual preferred stock, including related surplus (unless dividend resets periodically based on bank performance) (if it resets, it goes into Tier 2)
- Minority interests in equity capital accounts of consolidated subsidiaries
- MINUS – Disallowed goodwill and other intangibles (besides eligible MSRs, NMSAs, and PCCRs – see below)
- MINUS – Cumulative change in FV of liabilities (FAS 157)
SUBTOTAL – USED TO CALCULATE THE ALLOWABLE MSRS, NMSAS, PCCRS, AND DEFERRED TAX ASSETS
- MINUS - Disallowed Credit – Enhancing Interest-Only Strips - (Allowed 25% of SUBTOTAL Tier One above)
- MINUS - Disallowed intangible assets - (Not includible MSA, PCCA, NonMSAs up to 90% FV or 100% BV )
- MINUS - Identified losses - (e.g. securities, ORE, accrued interest, prepaid expenses)
- MINUS - Investments in securities subsidiaries - (Subject to 12 CFR Part 362 (Subpart E))
- MINUS - Ineligible Non Financial Equity Investments
- MINUS - Investment in Financial Subsidiaries
- MINUS - Underfunded portion of ALLL
- MINUS - Deferred tax assets in excess of the limit - (lesser of 10% of Tier 1 or amount expected to be realized within 1 year)
Define core capital (Tier 1).
Sum of core capital elements
o Minus all intangible assets (other than MSAs, NMSAs and PCCRs eligible for inclusion in core capital)
o Minus credit-enhancing interest-only strips that are not eligible for inclusion in core capital
o Minus disallowed deferred tax assets
o Minus any amount of nonfinancial equity investments
How do you calculate Tier 2 Capital?
Tier 2 Capital
• ALLL - up to 1.25% of gross RWA
• Cumulative perpetual preferred stock
• Long-term preferred stock - (original maturity of at least 20 years) and any related surplus
• Perpetual preferred stock - (where dividend is reset periodically)
• Hybrid capital instruments - (maturity is 12 years or less & includes convertible)
• Term subordinated debt - (limited to 50% of Tier 1 with 5 year original maturity)
• Intermediate-term preferred stock - (limited to 50% of Tier 1 with 5 year original maturity)
• Up to 45% of pretax net unrealized gains - (AFS equity securities / optional)
• Amount Transferred from T1 Capital - (To appropriately fund the ALLL)
What is Tier 2 Capital limited to?
Total of Tier 2 Capital - cannot exceed Tier 1 capital
How would preferred stock with an original maturity of 10 years fit into Tier 2 Capital?
It along with all term subordinated debt would be limited to 50% of Tier 1
How would preferred stock with an original maturity of 10 years fit into Tier 2 Capital?
It along with all term subordinated debt would be limited to 50% of Tier 1. Note: The combined amount of term-subordinated debt (excluding convertibles) and intermediate-term preferred stock (including related surplus) that may be treated as part of Tier 2 capital is limited to 50% of T1C.
What if Term subordinated debt or intermediate-term preferred stock is less than 5 years – how much do you include in Tier 2?
1-2yrs 20% 2-3yrs 40% 3-4yrs 60% 4-5yrs 80% >5yrs 100%
Note: The less than 5 year rule also applies to long-term preferred stock with an original maturity of 20 years or more. The entire amount is includible in T2C.
What is total risk based capital?
Tier 1 + Tier 2 Capital
What is included in Tier 3 Capital?
Unsecured subordinated debt with original maturity of 2+ years, not redeemable prior to maturity w/o FDIC consent, has lock in clause that prevents payment of P&I even at maturity if it would cause RBC ratio to fall and remain below minimum.
What limit is placed on Tier 2 plus Tier 3 Capital?
100% of Tier 1 Capital
At what point do the market risk-based capital rules apply with regard to trading activity for Tier 3 Capital?
Trading activity on a worldwide basis equals 10 percent or more of total assets or $1 billion or more
A bank subject to market risk rules for Tier 3 Capital must do what?
- Value-at-Risk Model - to estimate the maximum amount the bank’s covered positions could decline over a fixed period
- Independent Risk Control Unit - Have a risk management system, which is independent and defines a risk control unit that reports to senior management
- Daily Internal Risk Measurement Model - Have an internal risk measurement model integrated into the daily management process
What are the categories for Risk Weights for Balance Sheet Assets?
0%; 20%; 50%; 100%; and 200%
What is in Category 1 – 0%?
- Cash
- Gold bullion
- FRB Balances
- Central banks of OECD countries balances
- Guaranteed by US Gov’t Agencies (GNMA, VA, FHA, FMHA, FRB Bank, OPIC, CCC, SBA) or OECD Central Governments
- Local currency claims on or unconditionally guaranteed by non-OECD central governments
- Federal Reserve Bank stock
What is in Category 2- 20%?
- Correspondent bank balances and portions gty’d by banks
- Short-term claims on and portions gty’d by non-OECD banks
- Portions of loans and other claims conditionally guaranteed by US Treasury, US government agencies or OECD central banks
- Portions of conditionally guaranteed claims by non-OECD central governments
- Securities and claims gty’s on Gov’t sponsored agencies (FHLMC, SLMA & FHLB)
- General obligation securities of state or political subdivisions
- Loans collateralized by securities issued/guaranteed by gov’t (agency, sponsored agency, OECD) securities
- Secured by cash in a segregated account at a bank
- Cash items in process of collection
- Investment in mutual funds which only permit holding of 0% and 20% risk weighted assets
- Recourse obligations, direct credit substitutes, residual interests, and asset/mortgage backed securities
(Rated in the top two categories (AAA or AA) or the highest rating category for short term ratings (A-1 or P-1))
What is in Category 3 – 50%?
- Loans fully secured by first liens on a residential property made on prudent basis and not PD 90 days or more or nonaccrual
- Loans to builders with substantial project equity for construction of residences that have been pre-sold under firm contracts
- Loans secured by first liens on multifamily residential properties <=80% LTV, 1.20 DSC,
Amortization less than 30 years, payments made on time for minimum of 1 year, loan is not 90 days or more past due - Recourse obligations, direct credit substitutes, residual interests, and asset/mortgage backed securities
(Rated in the third-highest categories (A) or the second highest rating category for short term ratings (A-2 or P-2)) - Revenue bonds
What is in Category 4 – 100%?
- All claims on foreign and domestic private-sector obligors (including loans to nondepository banks and BHC)
- Claims on commercial firms owned by the public sector
- Customer liabilities to the bank on acceptances outstanding involving standard risk claims
- FA, premises, and ORE
- Common and preferred stock of corporations
- Commercial and consumer loans (except those assigned to lower risk categories)
- Recourse obligations, direct credit substitutes, etc. rated in the lowest investment grade (BBB)
- Industrial development bonds
- All obligations of states or political S/D of countries that do not belong to the OECD
- Stripped MBS and others (IO strips that are not credit-enhancing and principal-only strips)
- Claims representing capital of a qualifying securities firm
- Investments in unconsolidated companies, joint ventures; instruments that qualify as capital issued by other banks; deferred tax assets; MSAs, NMSAs, and PCCRs.
What is in Category 5 – 200% (Special treatment in Call Report b/c no column)
- Externally rated recourse obligations, direct credit substitutes, residual interests (other than a credit-enhancing interest only strip) ABS and MBS that are rated one category below investment grade (e.g. BB)
- A position in a securitization or structured finance program that is not rated by an NRSRO
What are the Conversion Factors for Off Balance Sheet Items?
100% Conversion Factor
• Financial SBLOC - Financial Standby Letters of Credit
• Forward agreements
• Participations sold with recourse
• Sale and repurchase agreements (Repo)
• Securities, indemnifies the customer against loss
50% Conversion Factor
• Pf – SBLOC - Performance standby letters of credit
• Unused portions of commitments with an original maturity exceeding one year
(Ex. Commercial LINE of Credit with a maturity exceeding 1 year)
• RUFs - Revolving Underwriting Facilities (RUFs, Contingent 1 Liab.)
• NIFs - Note Issuance Facilities (NIFs, Contingent 1 Liab.)
Note: If bank is subject to market risk rules in appendix C:
ABCP liquidity facilities (not eligible, considered recourse obligations or direct credit subs)
20% Conversion Factor
• Commercial letters of credit (contingencies that arise from the movement of goods, ST, self-liquidating, trade-related contingencies) (Ex. Commercial LETTER of Credit)
10% Conversion Factor
• ABCP liquidity facilities (unused portions)
0% Conversion Factor – Unused Commitments with the following:
• Original maturity of one year or less
• Retail credit card lines and related plans if unconditional option to cancel at any time
What is deducted from the denominator when calculating the RBC ratio? AKA. TRWA
All assets that are deducted from capital in the numerator.
(Only items that are risk-weighted and deducted from Total Capital)
• Intangibles other than allowed portion of MSRs, NMSAs, and PCCRs
• Investments in unconsolidated majority owned banking and finance subsidiaries
• Investments in securities subsidiaries (12 CFR 337.4)
• Reciprocal holdings of capital instruments banks
• Deferred tax assets disallowed for Tier 1
• The disallowed portion of the allowance.
What are some ways that a bank could increase its RBC ratios?
- Adjust portfolio to include lower risk weighted assets
- Less loans or more cash secured or 1-4 family 1st liens
- More USTs and GOs, rather than revenue obligations
- GNMAs instead of other government sponsored agency issues
What is each category of contingent liabilities?
- Category I contingent liabilities will result in a simultaneous increase in bank assets if it converts to an actual liability
- Category II contingent liabilities are those were a claim on assets arises without an equivalent increase in assets.
Note: Part 325 does not include off-balance sheet activities in the leverage capital calculations, but does indicate that off-balance sheet risk is one of the factors that will be considered in determining whether a higher minimum amount of capital should be required.
Are off-balance sheet risks included in the RBC calculations for risk-weighted assets?
Yes
What is the difference between loss contingency, potential loss, or estimated loss?
Loss Contingency: Existing condition involving uncertainty as to possible loss if/when future events occur or fail to occur
(Only refers to Category II)
Potential Loss: Contingent liabilities where there is substantial and material risk of loss
(Category 2 Liability, on Capital Calculations Page – Memo Section (not actually deducted from Capital).
Estimated Loss: From a loss contingency, recognized if probable that an asset has been impaired or a liability incurred as of the exam date and the amount of the loss can be reasonably estimated
(Category 2 Liability, On Capital Calculations Page – Other Adjustment to Tier 1 Capital (deduct from T1)
What are the primary risks associated with standby letters of credit?
Credit risk and funding risk (Liquidity)
What are some types of letters of credit?
- Travelers Letter of Credit - Addressed by bank to correspondents authorizing draft by person named meeting specified terms.
- Sold for Cash Letter of Credit - Sold, and bank receives funds from account party at issuance
(not a continent liability, but DDA) - Commercial Letter of Credit - Drafts drawn upon when underlying transaction consummated.
Facilitates trade and commerce.
(20% conversion factor) - Standby Letter of Credit – an irrevocable commitment by bank to make payment to a designated beneficiary and obligates the bank to guarantee or stand as surety for the benefit of a third party. SBLCs can be
- Financial - where account party is to make payment to the beneficiary (100% conversion factor)
- Performance - where a service is to be performed by account party (50 percent conversion factor)
What is a material adverse change clause in a line of credit?
Allows the bank to terminate the commitment or line of credit arrangement if the customers financial condition deteriorates.
What are the types of Category I and II contingent liabilities?
Category I – will give rise to an increase in assets if the contingent liability becomes an actual liability
- Letters of Credit
- Unfunded commitments
- Revolving Underwriting Facilities
- Banker’s Acceptances (for participating banks; accepting banks have a direct liability)
- Loan Sold without Recourse – but only in limited situations
- Asset Backed Commercial Paper Programs.
Category II – will not give rise to an increase in assets if the contingent liability becomes an actual liability
- Litigation
- Interest rate futures, forwards and standby contracts
- Trust activities
- Reserve Premium Accounts
- Cosigned Items and Other Non-ledger Accounts
a. Customer Safekeeping i.e. safe deposit boxes
b. Collection Items
c. Consigned Items (travelers checks, US Savings Bonds)
What are some UFIRS considerations for Capital?
- Overall Condition - The level and quality of capital and the overall financial condition of the institution
- Ability to Address Emerging Needs - The ability of management to address emerging needs for additional capital
- ALLL Adequacy - The nature, trend and volume of problem assets and the adequacy of the ALLL and other valuation reserves
- Balance Sheet Composition - , including amount of intangible assets, market risk, concentration risk, etc
- Off – Balance Sheet Items - Risk exposure from off balance sheet items
- Strength of Earnings / Reasonableness of Dividends - Quality and strength of earnings, and reasonableness of dividends
- Asset Growth - Prospects and plans for growth, as well as past experience in managing growth
- Access to Capital - Access to capital markets and other sources of capital
Capital Ratings
A rating of 1 indicates a strong capital level relative to the institution’s risk profile.
A rating of 2 indicates a satisfactory capital level relative to the financial institution’s risk profile.
A rating of 3 indicates a less than satisfactory level of capital that does not fully support the institution’s risk profile. The rating indicates a need for improvement, even if the institution’s capital level exceeds minimum regulatory and statutory requirements.
A rating of 4 indicates a deficient level of capital. In light of the institution’s risk profile, viability of the institution may be threatened. Assistance from shareholders or other external sources of financial support may be required.
A rating of 5 indicates a critically deficient level of capital such that the institution’s viability is threatened. Immediate assistance from shareholders or other external sources of financial support is required.
When a bank is inadequately capitalized do you cite a violation or a contravention of policy?
A violation is cited only if Tier 1 is under 3 or 4%.
A contravention is cited if a bank is undercapitalized due to either of the risk based capital ratios. Note: Violation of Part 325 is considered for leverage capital standards.
Contravention is cited if failure to meet RBC guidelines.
What is the Minimum Leverage Capital Requirement?
- 3% - fundamentally sound, well managed, no significant growth, “1”
- 4% – for all other institutions
What if the bank’s capital is under 4%?
It will prohibit any application from being approved and bank is required to file a written capital restoration plan to the FDIC RD within 45 days of date the bank receives notice or it represents an unsafe or unsound practice.
What constitutes an unsafe and unsound practice? (Per Capital Guidelines)
Being Undercapitalized and not submitting or being in compliance with a plan approved by the FDIC increase Tier 1 Leverage
For U, SU, or CU institutions under Part 325, a capital restoration plan must be submitted to RD entailing
SLOTH
- Steps the insured depository institution will take to become adequately capitalized
- Levels of capital to be attained during each year the plan will be in effect
- Other information as required under the particular Federal agency
- Types and levels of activities in which the institution will engage; and
- How the institution will comply with the restrictions in effect under PCA
Note: Must also have a performance guaranty and assurance from any controlling company that says the bank will comply with the plan until they are in compliance with capital requirements for 4 consecutive quarters.
What are the limitations on the required performance guarantees by any controlling company of a bank for purposes of a capital restoration plan______
5% of the bank’s TA at time of notice or amount to make the bank adequately capitalized. Expires after 4 consecutive quarters of being adequately capitalized.
How are intangibles valued?
• MSAs, Purchased CC Relationships and Non-MSAs
- Lesser of 90% of fair value or 100% of remaining unamortized book value.
- These assets will be limited to 100% of Tier 1 capital.
• Purchased CC Relationships and Non-MSAs
- Limited to 25% of Tier 1 capital.
• Deferred Tax Assets
- Limited to the lesser of the amount of DTA which can be recognized in the next 4 rolling quarters or 10% of Tier 1 capital
What is Well Capitalized?
- Total Risk Based Capital – 10.0% or greater
- Tier 1 Risk Based Capital – 6.0% or greater
- Leverage Ratio – 5.0% or greater
- Not subject to an written agreement
What is Adequately Capitalized?
- Total Risk Based Capital – 8.0% or greater
- Tier 1 Risk Based Capital – 4.0% or greater
- Leverage Ratio – 4.0% or greater OR 3.0% or greater and composite 1 rated, not experiencing significant growth
What is Undercapitalized?
- Below Adequately Capitalized
* Can have a leverage ratio below 3% if composite 1 rated, not experiencing significant growth
What is Significantly Undercapitalized?
- Total Risk Based Capital – less than 6.0%
- Tier 1 Risk Based Capital – less than 3.0%
- Leverage Ratio – less than 3.0%
What is Critically Undercapitalized?
Tangible equity to total assets equal to or less than 2.0%
What is Tangible equity capital?
- Tier 1 +
- cumulative perpetual preferred stock (including surplus)
- Less all intangible assets except eligible MSR.
When may FDIC reclassify a bank from Well Capitalized to Adequately Capitalized?
- Unsafe & Unsound Practice or Condition
2. Consent Order with capital provision
May the FDIC reclassify an institution from Significantly Undercapitalized to Critically Undercapitalized?
No
Under Section 38(d) what restrictions are there on all banks?
Pay capital distributions or management fees causing it to become undercapitalized.
What are the 5 things U, SU, CU banks are subject to and what are they?
- Expansion Approval - Expansion proposals Require prior approval
- Capital Restoration Plan - required to be submitted
- Monitoring - FDIC monitoring of the condition of the bank required
- Restricted Growth - Growth of the bank’s assets restricted
- Capital distributions - restricted
- Management fees - restricted
When will an Undercapitalized bank be subject to the provisions for a Significantly Undercapitalized bank? (3 times)
- Capital restoration plan was submitted, but disapproved
- Failure to submit a capital restoration plan within the period provided (45 days)
- Failure to materially comply with an approved capital restoration plan
SU, CU banks or U banks that have failed to submit /implement an acceptable capital restoration plan are also?
Per Appendix A of 325 - Restricted on compensation paid to senior executive officers of the institution
Per Section 38 of FDI Act – SU or Undercapitalized Banks (that fail to submit/implement plans) are also subject to:
- Management - improve (elect new directors, dismiss dire/EO, employ new EO)
- Other activities - certain activities restricted
- Recapitalization - required
- Transactions with affiliates - restricted
- Correspondent bank deposits - restricted
- Asset growth - restricted
- Interest rates paid on deposits - restricted
- Capital distributions by BHC - required prior approval
- Divestiture - required
Who can issue a capital directive and when can a directive be issued? (Part 325.6)
Issued by FDIC BOD or its designee:
- Bank fails to maintain capital at or above the minimum leverage capital requirement
- Can only be used for SNMs
A directive is the equivalent of which formal or informal enforcement action?
Cease and desist
When the FDIC issues a directive to a bank, what is included in the written notification?
- T1 Leverage Capital Ratio
- Basis for calculation
- Proposed capital injection
- Proposed date for achieving the minimum leverage capital requirement
- Other relevant information
If a bank is critically undercapitalized the following provisions are applicable (Section 38 FDIC Act):
- Activities are restricted (see below)
- Payments on subordinated debt are prohibited
- Conservatorship, receivership, or other action required.
What 8 actions require prior written FDIC approval for CU banks?
- Bylaws / Charter - Amending the institution’s charter or bylaws
- Leveraged Transactions - Extending credit for any highly leveraged transaction
- Unusual business activities - Entering into any material transaction other than in the usual course of business
- Sec 23A Covered Trans - Engaging in any covered transaction (23A)
- Accounting Method Changes - Making any material change in accounting methods
- Excessive Compensation - Paying excessive compensation or bonuses
- Paying P&I on Sub Debt - Making any principal or interest payment on subordinated debt beginning 60 days after
- Above market rates - Paying above market deposit rates
What is the Leverage Capital ratio?
Tier 1/ adjusted average assets** (average assets for the quarter)
** Need to remember to subtract assets which are deducted from Tier 1 Capital (e.g. disallowed intangibles and Loss)
What are the two exceptions from Call Report Instructions for calculating Tier 1 Capital and RWA?
V. Analysis of Consolidated Companies
- Securities subsidiaries shall not be accounted towards the bank’s capital and must be accounted for by the equity method while for the Call Report many may have consolidated on a line by line bases
- Call report instructions require that a domestic depository institution subsidiary be accounted for by the equity method, a line by line consolidation needs to be done for Tier 1 and RBC.
Part 325, Appendix C – RBC for state non-member banks; market risk
This part adjusts the RBC ratios for which institutions?
Any SNM bank whose trading activity equals (Tier 3):
• TA > $1 billion OR
• >10% of TA as trading assets
