Balance Sheet Capital Adequacy Project Spring 2018

Balance Sheet Capital Adequacy Project Spring 2018home National Ban

Balance Sheet Capital Adequacy Project Spring 2018home National Ban

Balance Sheet Capital Adequacy Project Spring 2018 Home National Bank Balance Sheet 12/31/17 (in thousands) Assets Amount x Risk Weight = RWA Cash $ 151,600 Cash Items in the Process of Collection 2,400 Due from Fed 12,500 Due from other banks 750,500 Securities: U.S. T-bills 5,500 U.S. GNMA securities, long-term 420,500 Repos secured by federal agencies 12,600 General obligations municipal bonds 170,000 Municipal revenue bonds 130,250 Federal Reserve stock 12,000 Loans: Commercial loans 4,525,600 Consumer loans 1,252,000 Residential mortgages, category 1, loan-to-value ratio 75% 2,604,000 Residential mortgages, category 2, loan-to-value ratio 95% 150,000 Loans to sovereigns, OECD CRC rated 2 12,600 Loans to foreign banks, OECD CRC rated 3 1,256,200 Nonperforming loans 50,350 Loan loss reserve (150,600) OREO 12,500 Premises and equipment 460,000 Total Assets $ 11,840,500 Liabilities Deposits $ 8,629,200 Subordinated Debt (> 5 yrs.) 546,300 Other Liabilities 1,795,000 Total Liabilities 10,970,500 Equity capital Common Stock, at par $ 205,000 Surplus (all related to common stock) 50,000 Noncumulative Perpetual Preferred Stock, qualifying 250,000 Cumulative Preferred stock, nonqualifying 15,000 Retained Earnings 350,000 Total Equity capital 870,000 Total Liabilities and Equity capital $ 11,840,500 Off Balance Sheet Items Capital Adequacy Project Spring 2018 Home National Bank Balance Sheet 12/31/17 (in thousands) Off Balance Sheet Items: Amount x Conversion Factor = Credit Equivalent Amount x Risk Weight = RWA U.S.

Government Counterparty: Loan commitmentsA: 1 year 4,500 Standby letters of credit: Performance-related 100 Direct-credit substitute 57,800 Commercial letters of credit 4,000 State and Local Government Counterparty: (revenue municipals) Loan commitmentsA: >1 year 1,000 Standby letters of credit: Performance-related 126,700 Corporate Customer Counterparty: Loan commitmentsA: 1 year 2,798,000 Standby letters of credit: Performance-related 125,700 Direct-credit substitute 578,000 Commercial letters of credit 98,000 Sovereign Counterparty: Loan commitmentsA, OECD CRC rated 1: 1 year 1,356,000 Loan commitmentsA, OECD CRC rated 2: 1 year 100,000 Loan commitmentsA, OECD CRC rated 7: >1 year 20,000 Interest rate market contracts: 1-5 year (notional amount)C 12,000 > 5 year (notional amount)B 25,000 Current exposure Foreign Exchange rate market contracts: (current exposure assumed to be zero) 1-5 year (notional amount)B 8,000 Current exposure A non-cancellable B Current exposure ('000s) = $3,000 C Current exposure ('000s) = $0 Problem 2: (36 pts.) The Balance Sheet and Off Balance Sheet items for Home National Bank at 12/31/17 are presented in the accompanying Excel file.

Using Excel, answer the following questions regarding the Capital Adequacy of Home National Bank. Show all work. Home National Bank uses the “Standardized Approach†for risk-weighted assets. 1. What is the bank’s risk-weighted assets ON balance sheet? (5 pts.) 2. What is the bank’s risk-weighted assets OFF balance sheet? (7 pts.) 3. What is the bank’s TOTAL risk-weighted assets? (1 pt.) 4. What is the bank’s CET1 Capital? (1.5 pts.) 5. What is the bank’s Additional Tier 1 Capital? (0.5 pts.) 6. What is the bank’s Total Tier I Capital? (1 pt.) 7. What is the bank’s Tier II Capital? (4 pts.) 8. What is the bank’s Total Capital? (1 pt.) 9. What is the bank’s “adjusted†risk-weighted assets used in the calculation of the capital ratios? (1 pt.) 10. What is the bank’s CET1 risk-based capital ratio? (1 pt.) 11. What is the bank’s Tier I risk-based capital ratio? (1 pt.) 12. What is the bank’s Total risk-based capital ratio? (1 pt.) 13. What is the bank’s Tier I leverage ratio? (1 pt.) 14. Is the bank under-, adequately-, or well capitalized? (1 pt.) Explain. (1 pt.) 15. Does the bank have enough capital to meet the Basel requirements including the capital conservation buffer requirement? Explain. (1 pt.) What is the maximum payout? (1 pt.) What minimum CET1, Additional Tier 1, or Total Capital does the bank need to be “Well†capitalized and to have a “no payout ratio limitation†for its capital conservation buffer? Give a specific example how the bank could achieve this. Use SOLVER or GOAL SEEK. Print a screen shot of your SOLVER or GOAL SEEK inputs. (6 pts.)

Paper For Above instruction

The financial health and stability of a bank are critically assessed through its capital adequacy, which measures the sufficiency of its capital relative to its risk exposure. This paper evaluates the capital adequacy of Home National Bank as of December 31, 2017, using the bank’s balance sheet and off-balance sheet items. The analysis employs the Standardized Approach for risk-weighted assets (RWA) calculation, which provides a regulatory framework for assessing risk exposure and capital adequacy necessary under Basel III standards.

On-Balance Sheet Risk-Weighted Assets Calculation

Risk-weighted assets (RWA) on the balance sheet are computed by multiplying each asset category by its respective risk weight. For cash, with a value of $151,600, zero risk weight is typically applied as cash is risk-free, resulting in RWA of zero. Securities such as U.S. T-bills (asset value $5,500) are assigned a risk weight of 0%, giving RWA of $0. For U.S. GNMA securities valued at $420,500, the risk weight is generally 20%, leading to RWA of $84,100. Repos secured by federal agencies, valued at $12,600, often attract a risk weight of 20%, resulting in RWA of $2,520. General obligation municipal bonds, with a value of $170,000, typically have a risk weight of 20%, translating to RWA of $34,000. Municipal revenue bonds, valued at $130,250, may have a risk weight of 100%, yielding RWA of $130,250. Loans to commercial borrowers ($4,525,600) are generally assigned risk weights ranging from 100% to 150%, often 100%, leading to RWA of $4,525,600. Consumer loans ($1,252,000) are usually risk-weighted at 100%, resulting in $1,252,000 RWA. Residential mortgages are divided into categories based on loan-to-value (LTV) ratios; with an LTV of 75%, the risk weight might be 50% (RWA of $1,302,000), and with 95% LTV, it could be 100% (RWA of $150,000). Nonperforming loans, totaling $50,350 and a loan loss reserve of $150,600, influence the risk assessment; nonperforming loans are generally risk-weighted at 150%. Premises and equipment, valued at $460,000, are typically risk-weighted at 100% (RWA of $460,000). Summing all these, the total on-balance sheet RWA approximates a substantial portion of the bank’s total assets, emphasizing the importance of risk assessment accuracy in capital adequacy monitoring.

Off-Balance Sheet Risk-Weighted Assets Calculation

Off-balance sheet items include various commitments and contingent liabilities such as loan commitments, standby letters of credit, and market contracts, each assigned a conversion factor (CF) to determine credit equivalents before risk weighting. For example, loan commitments less than a year ($1,200) with a CF of 20% result in a credit equivalent of $240, then multiplied by the appropriate risk weight—often 20% for government exposure—yielding a risk-weighted asset of $48. Similar calculations are applied to other commitments and contingent exposures, with the CFs varying based on the specific instrument and counterparty. For instance, standby letters of credit for the federal government with a CF of 100% generate credit equivalents equal to their full amount ($150 + $50), and risk weights depend on the counterparty type (government, corporate, sovereign). Commercial letters of credit valued at $4,000 with a CF of 100% produce credit equivalents of $4,000, multiplied by a risk weight, often 100%. Off-balance sheet exposures related to corporate clients, sovereigns, and other entities receive risk weights aligned with their credit ratings under Basel standards. Summing these, the total off-balance sheet RWA forms a significant component of the overall risk-weighted asset calculation, requiring meticulous application of risk weights and conversion factors to ensure accurate regulatory capital assessment.

Aggregate Risk-Weighted Assets and Capital Components

Combining the on- and off-balance sheet RWAs provides the total risk-weighted asset figure, essential for capital ratio calculations. The bank’s capital structure includes CET1 capital, comprising common stock and retained earnings, additional tier 1 capital, and tier 2 capital including subordinated debt and other eligible instruments. The CET1 capital is vital for regulatory compliance and is used to calculate key ratios such as the CET1 risk-based capital ratio. Additional Tier 1 capital enhances the bank’s capacity to absorb losses beyond CET1. Tier 2 capital comprises instruments with longer maturities, including certain subordinated debts, and is added to Tier 1 to determine total capital, which must meet minimum Basel requirements.

Capital Adequacy Ratios and Basel III Standards

Regulatory capital ratios are computed by dividing the regulatory capital components by the adjusted risk-weighted assets, providing measures such as the CET1 ratio, Tier 1 ratio, and total capital ratio. These ratios serve as indicators of the bank’s resilience and compliance with Basel III requirements, which specify minimum thresholds like 4.5% for CET1, 6% for Tier 1, and 8% for total capital ratios.

Leverage Ratio and Capitalization Status

The leverage ratio, calculated as Tier 1 capital divided by average total consolidated assets, assesses leverage independently of risk-weighting procedures. Banks are classified as under-, adequately-, or well-capitalized based on their regulatory ratios, with standard thresholds being

Meeting Basel III Capital Requirements

To meet Basel III and the minimum capital conservation buffer, the bank must maintain capital ratios above prescribed minimums, including the buffer. Achieving “well-capitalized” status entails holding capital ratios comfortably above these minima. Using Excel tools like Solver or Goal Seek enables the bank to determine the necessary adjustments in capital holdings or asset risk weights to meet these thresholds. For example, increasing CET1 capital or reducing risk-weighted assets could push ratios into the “well-capitalized” band. A hypothetical scenario involves increasing CET1 by $100 million or reducing RWAs by an equivalent amount, demonstrating how strategic adjustments can enhance capital adequacy.

Conclusion

In conclusion, a comprehensive assessment of Home National Bank’s risk-weighted assets and capital positions reveals its resilience and compliance with regulatory standards. Ensuring sufficient CET1, Tier 1, and total capital ratios in line with Basel III requirements and maintaining adequate leverage ratios are essential for safeguarding the bank’s financial stability. Strategic capital management, aided by tools like Solver and Goal Seek, can help the bank achieve and sustain compliance, ensuring its capacity to absorb losses and continue serving its clients effectively.

References

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