Must Know - Capital Flashcards
The four purposes of capital
- Absorb losses
- Promotes public confidence
- Helps restrict excessive asset growth
- Provides protection to depositors and the DIF
The components of and how to calculate Tier 1 Capital
- +common stockholder’s equity
- +noncumulative perpetual preferred stock
- +Minority interests in consolidated subs
- – All intangible assets other than servicing assets, purchased credit card relationships
- – Noneligible credit enhancing interest-only strips
- – Deferred tax assets, lesser of not used in the next year or 10% of TI Capital
- – Identified losses
- – Investments in financial subs that conduct activities not permissible for a bank (investment equity and pro rata share of RE)
- Total adjusted carrying value of nonfinancial equity investments (that increase as the aggregate amount of nonfinancial equity investments held by the bank increases)
The components of and how to calculate Tier 2 Capital
- ALLL
- Cumulative perpetual preferred stock, long term pref stock, and any related surplus
- Perpetual preferred stock where the dividend is reset periodically based on the banks credit standing
- Hybrid capital instruments (permanent), including mandatory convertible debt
- Term subordinated debt and intermediate-term preferred stock (>5yrs and not redeemable)
- Net unrealized holding gains and losses on equity securities up to 45% pretax
- Tier 2 capital is limited to 100% of T1 Capital and the combined amount of term subordinated debt and intermediate-term preferred stock that may be treated as Tier 2 capital is limited to 50 percent of Tier 1 capital.
The components of and how to calculate Total Capital
Total Capital (used in the risk-based calculation) is calculated by summing Tier 1 capital and Tier 2 capital, less investments in unconsolidated banking and finance subsidiaries and reciprocal holdings of capital instruments of other banks.
How to calculate the Tier 1 Leverage Capital Ratio
Tier 1 Capital / Adjusted Average Assets**
** AA from RC-K adjusted for deductions from Tier One Capital (e.g. disallowed intangibles and Loss)
How to calculate the Tier 1 Risk-Based Capital Ratio
Tier 1 risk-based capital / Risk-weighted assets**
** AA from RC-K adjusted for deductions from Tier One Capital (e.g. disallowed intangibles and Loss)
Under what conditions Tier 3 Capital applies
Tier 3 Capital is limited in use to situations where the market risk risk-based capital rules apply. The market risk risk-based capital rules and calculations only apply to insured state nonmember banks whose trading activity (on a worldwide basis) equals 10 percent or more of total assets or $1 billion or more. Tier 3 capital includes subordinated debt with specific characteristics and just applies to these market risk rules. A bank subject to the market risk rules must:
• use a value-at-risk model to estimate the maximum amount that the bank’s covered positions could decline during a fixed holding period,
• have a risk management system, which defines a risk control unit that reports directly to senior management and is independent from business trading units, and
• have an internal risk measurement model that is integrated into the daily management process, and must have policies and procedures that identify appropriate stress tests and back tests, which the bank must conduct.
How to properly adjust capital for examination findings (loan losses, OREO losses, underfunded ALLL, etc.)
ALLL -
Deduct the amount of Loss for items other than loans and leases in the calculation of Tier 1 capital. If Other Real Estate (ORE) general reserves exist, see the following discussion of “Capital Treatment of ORE Reserves.”
• Deduct the amount of Loss for loans and leases from the ALLL in the calculation of Tier 2 capital.
• If the ALLL is considered inadequate, an estimate of the provision expense needed for an adequate ALLL should be made. The estimate is after identified losses have been deducted from the ALLL. Loans and leases classified Doubtful should not be directly deducted from capital. Rather, they should be included in the evaluation of the ALLL and, if appropriate, will be accounted for by the inadequate ALLL adjustment.
• An adjustment from Tier 1 capital to Tier 2 capital for an inadequate ALLL should be made only when the amount is considered significant. The decision as to what is significant is a matter of judgment.
ORE - ORE reserves, whether considered general reserves or specific reserves, are not recognized as a component of capital for either risk-based capital or leverage capital standards. However, these reserves would be considered when accounting for ORE that is classified Loss. Examiners should take into account the existence of any general ORE reserves when deducting ORE classified Loss. To the extent ORE reserves adequately cover the risks inherent in the ORE portfolio as a whole, including any individual ORE properties classified Loss, there would be no actual deduction from Tier 1 capital. The ORE Loss in excess of ORE reserves should be deducted from Tier 1 capital under “Assets Other Than Loans & Leases Classified Loss.”
Liabilities Not Shown on Books - non-book liabilities for which an adjustment should be made in the examination capital analysis. Similarly, an adjustment to capital should be made for material deferred tax liabilities or for a significant amount of unpaid bills that are not reflected on the bank’s books.
When a bank is required to enter into a Written Agreement with the FDIC
Section 325.4(c) provides that any insured depository institution with a Tier 1 capital to total assets ratio of less than 2 percent must enter into and be in compliance with a written agreement with the FDIC
The three options for increasing capital
- Increased earnings retention
- Reduced assets (growth)
- Sale of additional capital stock
The difference between Category I and Category II Contingent Liabilities
Category I contingent liabilities are those that will result in a concomitant increase in bank assets if the contingencies convert to actual liabilities. Category II contingent liabilities include those in which a claim on assets arises without an equivalent increase in assets.
The difference between how adversely classified Category I and Category II Contingent Liabilities are treated in the ROE and how they affect capital
If a Category I contingent liability is classified Loss, it would be included in the Assets Other Than Loans & Leases Classified Loss category on the Capital Calculations page. The memorandum section of the Capital Calculations page includes the dollar amount of Category II contingent liabilities, as well as the Category I contingencies. Any Potential Loss identified is also reflected in the memorandum section and only refers to Category II contingent liabilities. Estimated Losses related to Category II contingent liabilities are reflected in this schedule as adjustments to capital by including them in the Other Adjustments to (from) Tier 1 capital line item. Estimated Losses are not included as adjustments to assets.
Minimum capital requirements per Part 325 and Appendix A to Part 325
Not less than 3 percent Tier 1 capital to total assets if the bank has a composite “1” rating and is not anticipating or experiencing any significant growth and has well-diversified risk, including interest rate risk, excellent asset quality, high liquidity, and good earnings.
All others not meeting the above criteria should maintain a ratio of Tier 1 capital to total assets of not less than 4 percent.
When an institution is considered to engaging in an unsafe and unsound practice with regards to capital levels, versus when it is considered to be in an unsafe and unsound condition
Any bank that has less than the minimum leverage capital requirement is deemed to be in violation of Part 325 and engaged in an unsafe or unsound practice pursuant to section 8(b) and/or 8(c) of the FDI Act, unless the bank has entered into and is in compliance with a written plan approved by the FDIC.
If a bank has a leverage ratio less than two percent, it is deemed to be operating in an unsafe or unsound condition pursuant to section 8(a) of the FDI Act.
On-Balance Sheet Risk Weighting – 0%
- Cash
- Central banks of OECD countries balances
- Federal Reserve Bank stock
- FRB Balances
- GNMA Securities
- Gold bullion
- Guaranteed by US Gov’t Agencies (GNMA, VA, FHA, FMHA, ExIm Bank, OPIC, CCC, SBA) or OECD Central Governments
- Local currency claims on or unconditionally guaranteed by non-OECD central governments
- SBA Securities
- US Treaury Bond
- Vault Cash
On-Balance Sheet Risk Weighting – 20%
- Cash items in process of collection
- Correspondent bank balances and portions gty’d by banks
- Due from Banks
- FHLB Stock
- FHLMC - Pass through
- General obligation securities of state or political subdivisions
- GO Bonds
- Investment in mutual funds which only permit holding of 0% and 20% risk weighted assets
- Loans collateralized by securities issued/guaranteed by gov’t (agency, sponsored agency, OECD) securities
- Loans gtyd by FHA
- Loans secured by cash• Portions of conditionally guaranteed claims by non-OECD central governments
- Portions of loans and other claims conditionally guaranteed by US Treasury, US government agencies or OECD central banks
- 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))
- Secured by cash in a segregated account at a bank
- Securities and claims gty’s on Gov’t sponsored agencies (FHLMC, FNMA, SLMA & FHLB)
- Short-term claims on and portions gty’d by non-OECD banks
On-Balance Sheet Risk Weighting – 50%
- 1-4 Family Mtg
- Loans fully secured by first liens on a residential property made on prudent basis and not PD 90 days or more or nonaccrual
- 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
- Loans to builders with substantial project equity for construction of residences that have been pre-sold under firm contracts
- Municipal Water Revenue
- 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
On-Balance Sheet Risk Weighting – 200%
- A position in a securitization or structured finance program that is not rated by an NRSRO
- 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)
Off-Balance Sheet Risk Weighting 0% - 20%
Unused portions of commitments with an original maturity of one year or less 0%
Unused portions of retail credit card lines and related plans if unconditional option to cancel at any time 0%
Lent Securities that are supported by an appropriate amount of collateral that qualifies for 0% risk weighting 0%
ABCP liquidity facilities (unused portions) 10%
6-month loan commitment to commercial borrower 20%
Commercial letters of credit (contingencies that arise from the movement of goods, ST, self-liquidating, trade-related contingencies) (Ex. Commercial LETTER of Credit) 20%
Lent securities that are supported by an appropriate amount of collateral that qualifies for 20% risk weighting or <1yr 20%
Off-Balance Sheet Risk Weighting 50%
- Note Issuance Facilities (NIFs, Contingent 1 Liab.)
- Performance standby letters of credit
- Revolving Underwriting Facilities (RUFs, Contingent 1 Liab.)
- Unfunded HELOC, greater than 1 yr, 2nd lien
- Unused portions of commitments with an original maturity exceeding one year (Ex. Commercial LINE of Credit with an original maturity exceeding 1 year)
Off-Balance Sheet Risk Weighting 100%
- Financial SBLOC
- Financial Standby Letters of Credit
- Forward agreements
- Participations sold with recourse
- Sale and repurchase agreements (Repo)
- Securities, indemnifies the customer against loss
- Lent securities not risk weighted lower (credit equivalent amount)
Off-Balance Sheet Risk Weight
- First, apply the conversion factor. Second, Risk Weight the Asset as usual.
- If you have funded & unfunded loan, this only applies to the off-balance sheet portions.
