Onshore Bank has $20 million in assets, with risk-adjusted assets of $10 million
ID: 1191336 • Letter: O
Question
Onshore Bank has $20 million in assets, with risk-adjusted assets of $10 million. CET1 capital is $500,000, additional Tier I capital is $50,000, and Tier II capital is $400,000. How will each of the following transactions affect the value of the CET1, Tier I, and total capital ratios? What will the new value of each ratio be?
The current value of the CET1 ratio is 5 percent, the Tier I ratio is 5.5 percent, and the total ratio it 9.5 percent.
a. The bank repurchases $100,000 of common stock with cash.
b. The bank issues $2 million of CDs and uses the proceeds to issue category 1 mortgage loans with a loan-to-value ratio of 80 percent.
c. The bank receives $500,000 in despotis and invests them in T-bills.
d. The bank issues $800,000 in common stock and lends it to help finance a new shopping mall.
e. The bank issues $1 million in nonqualifying perpetual preferred stock and purchases general obligation municipal bonds.
f. Homeowners pay back $4 million of mortgages with loan-to-value ratios of 40 percent and the bank uses the proceeds to build new ATM's.
Explanation / Answer
The current value of the CET1 ratio is 5 percent ($500,000/$10m), of the Tier I ratio is 5.5percent (($500,000 + $50,000)/$10m), and the total ratio is 9.5 percent (($500,000 + $50,000 +$400,000)/$10m).
(a)
CET1 capital decreases to $400,000, Tier I capital decreases to $450,000 and total capital decreases to $850,000. Cash has a 0 risk weight so risk-weighted assets do not change. Thus, theCET1 ratio decreases to 4 percent, the Tier I ratio decreases to 4.5 percent and the total capitalratio decreases to 8.5 percent.
(b)
The risk weight for uninsured mortgages is 35 percent. Thus, risk-weighted assets increase to$10 million + $2 million (0.35) = $10.7 million. The CET1 ratio decreases to $500,000/$10.7million = 4.67 percent, the Tier I ratio decreases to $550,000/$10.7 million = 5.1 percent and thetotal capital ratio decreases to $950,000/$10.7 million = 8.88 percent.
(c)
The three ratios remain the same since T-bills have a 0 risk weight and risk-weighted assets remain unchanged.
(d)
CET1 equity increases to $1.3 million, Tier I equity increases to $1.35 million, and total capitalincreases to $1.75 million. The business loan’s risk weight is 50 percent. Thus, risk-weightedassets increase to $10 million + $800,000 (0.5) = $10.4 million. The CET1 ratio, increases to$1.3m/$10.4m = 12.5 percent, the Tier I ratio increases to $1.35m/$10.4m = 12.98 percent, andthe total capital ratio increases to $1.75/10.4 = 16.83 percent.
(e)
CET1 and Tier I capital are unchanged. Total capital increases to $1.95 million. Generalobligation municipal bonds fall into the 20 percent risk category. So, risk-weighted assetsincrease to $10 million + $1 million (0.2) = $10.2 million. Thus, the CET1 ratio decreases to $500,000/$10.2 million = 4.90 percent, the Tier I ratio decreases to $550,000/$10.2 million =5.39 percent, and the total capital ratio increases to 19.12 percent.
(f)
The mortgage loans have a risk weight of 35 percent. The ATMs are 100 percent risk weighted. Thus, risk weighted assests increase to $ 10 million - $ 4 million (0.35) + $ 4 million (1.0) = $12.6 million. The CET1 capital ratio decreases to $ 550,000/$12.6m = 4.36 percent , and the total capital ratio decreases to $950,000/$12.6m =7.54 percent.
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