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# Problems and Solutions on Capital Adequacy ratio

## Problem 1 Using the figures below:

Perpetual preferred stock Common stock Surplus Undivided profit and reserve Foreign currency translation adjustments Mandatory convertible debenture \$ 1,644,000,000 31,428,000,000 71,412 44,060 (298) 3,001 Minority interest in subsidiaries Subordinated notes and debentures Intangible assets Limited life preferred stock Allowance for loan losses Total assets (book value) Total liabilities Equity notes \$ 3,075 20,998 5,070 102 54,077 3,355,666 3,120,501 815

Calculate: a. GAAP; b. RAP; c. Primary capital; d. Secondary capital. core capital (Tier 1), and Supplementary capital (Tier 2). Solution a. GAAP capital = Assets book value liabilities book value = 3,355,666 3,120,501 = 235,165 million b. RAP capital = Stockholders equity + Preferred stock + Loss reserves + Subordinated debentures + Miscellaneous items = (31,428 + 71,412 + 44,060) + 1,644 + 54,077 + 20,998 + (3,075 + 815) = 227,509 million c. Primary capital = Common stock + Perpetual preferred stock + Surplus + Undivided profits and reserves + Mandatory convertible debt + Loss reserves + Minority interest in subsidiaries Equity commitment notes Intangible assets = 31,428 + 1,644 + 71,412 + 44,060 + 3,001 + 54,077 + 3,075 815 5,070 = 202,812 million d. Secondary capital = Limited life preferred stock + Subordinated debentures = 102 + 20,998 = 21,100 million e. Core or Tier one capital = Common stock + Surplus + Retained earnings + Perpetual preferred stock + Minority interest in subsidiaries Goodwill = 31,428 + 71,412 + 44,060 + 1,644 + 3,075 5,070 = 146,549 million f. Supplementary or Tier 2 capital = Allowance for loan and lease losses + Debt capital + Equity notes + Limited life preferred stock = 54,077 + 23,999 + 815 + 102 = 78,993 million Problem 2 Consider the following balance sheet information on Willow River National Bank: On balance sheet items include: Cash \$ 120 million Domestic inter-bank deposits 240 million U.S. government securities 450 million Residential real estate loans 370 million Commercial loans 520 million Total assets \$ 1,700 million

Total liabilities \$ 1,569 million Total capital \$ 136 million Off balance sheet items include: Standby credit letters \$ 75 million long term loan commitments to private companies 180 million a. Please calculate Willow River National Banks total risk weighed assets, based on the items that the bank reported on its latest balance sheet, shown above. Does the bank appear to have a capital deficiency? b. Suppose that Willow River National Bank, whose balance sheet is above, reports the forms of capital shown in the table below as of the date of its latest financial statement. Common stock (par value) \$ 18 million Surplus 22 million Undivided profits 84 million Allowance for loan losses 75 million Subordinated debt capital 40 million Intermediate term preferred stock 12 million What is the total dollar volume of the banks Tier I capital? Tier capital? According to the data given, does Willow River National Bank have a capital deficiency? Solution a. Calculation of on-balance sheet items and credit equivalent off balance sheet items: Assets items Risk weight Cash \$ 120 0 = 0 U.S. government securities \$ 450 0 = 0 Domestic inter-bank deposits \$ 240 0.20 = 40 million Standby credit letters \$ 75 0.20 = 15 million Residential real estate loans \$ 370 0.50 = 185 million Commercial loans \$ 520 1.00 = 520 million Long term corporate credit commitments \$ 90 1.00 = 90 million Total risk weighted assets \$ 850 million Willow Rivers overall capital to assets ratio is: \$ 136 million Total capital Capital adequacy ratio = Total risk weighted assets = \$850 miliion = 0.16 or 16% Overall, it does not appear from the information given above that Willow River has a capital deficiency. b. Willow River National Bank has the following Tier I and Tier 2 capital items and totals: Tier 1 capital = Common stock (par) + Surplus + Undivided profit = 18 + 22 + 84 = 124 million Tier 2 capital = Allowance for loan loss + Subordinated debt capital + Intermediate term preferred stock = 75 + 40 + 12 = 127 million The bank appears to have enough Tier 1 capital to meet current regulatory requirements. However, it has excessive Tier 2 capital which is not supposed to exceed 100 percent of Tier 1 capital.

Problem 3 Using the information presented below for Premier Western National Bank, calculate that banks required level of capital based on the new international capital standards. Does the bank have sufficient capital under the new international capital standards?
On balance sheet items (assets) Cash U.S. Treasury securities Deposit balances due from other banks Loans secured by first lines on residential property (1-4 family dwellings) Loans to corporations Total assets \$ 2.5 million 25.6 4.0 8.7 108.4 \$ 149.2 million Off balance sheet items standby credit letters backing municipal bonds Long term binding commitments to corporate customers total of all off-balance sheet items \$ 18.1 40.2 \$ 58.3 million

total capital

\$10.5 million

Solution Calculation of risk weighted assets Assets items Risk weight Cash \$ 2.5 0 = 0 U.S. Treasury securities \$ 25.6 0 = 0 Balances at domestic banks \$ 4 0.20 = 0.80 million Credit equivalent amounts of standby credits \$ 18.1 0.20 = 3.62 million Residential real estate loans \$ 8.7 0.50 = 4.35 million Loans to corporations \$ 108.4 1.00 = 108.4 million Credit equivalents of long term commitments \$ 20.1 1.00 = 20.1 million Total risk weighted assets \$ 137.27 million Total capital \$ 10.5 million Capital adequacy ratio = Total risk weighted assets = \$137.27 miliion = 0.0765 or 7.65% The capital adequacy ratio is just below the minimum total capital (Tier one + Tier two) requirement of 8 percent. Premier will probably need to raise additional capital. Problem 4 Silsbee National Bank and Trust Company reported its capital position to examiners earlier this month. The bank currently has \$ 825 million in total assets, \$ 779 million in total liabilities, and \$ 46 million in total capital, broken down in this table: Components of total capital Dollar amount of each capital component (millions) common stock \$ 3.1 Surplus on common 4.70 Perpetual preferred stock 0.80 Surplus on preferred 0.60 Limited life preferred stock 0.20 Retained earnings 26.3 Mandatorily convertible capital notes and debentures 5.9 Reserve for loan losses 4.4 \$ 46.0 million Silsbees current price on its common stock is \$ 3.50 per share, with 10 million common equity shares outstanding. It has 50,000 shares of preferred stock outstanding at \$ 10 per share. a. What is the market value of the banks capital?

What size capital deficiency does the bank have, if any, according to the international capital standards? Solution a. Market value of common stock = Price Number of shares = \$ 3.50 10,000,000 = \$ 35,000,000 Market value of preferred stock = Price Number of shares = \$ 10 50,000 = \$ 500,000 The total market value of the banks stock = \$ 35,000,000 + \$ 500,000 = \$ 35,500,000 b. Tier 1 Capital = \$ 3.1 + 4.7 + 26.3 + 0.8 + 0.6 = 35.5 million Tier 2 Capital = 4.4 + 5.9 + 0.2 = 10.5 Tier 1 capital \$ 35.5 million Tier 1 capital ratio = Total assets = \$825 miliion = 0.043 or 4.3% Tier 2 capital \$ 10.5 million Tier 2 capital ratio = Total assets = \$825 miliion = 0.0127 or 1.27% Total capital \$ 46 million Total capital ratio = Total assets = \$825 miliion = 0.0558 or 5.58% The total capital to total assets ratio is well below the 8 percent level. The tier 1 capital ratio is satisfactory; however, the tier 2 capital ratio is very low.

b.