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Regulatory Capital Categories for Banks and S&Ls

Philip van Doorn

When we speak of banks that are "well-capitalized" or "undercapitalized," we are using strictly-defined regulatory terms.

There are five regulator-defined capital categories used to describe an institution's capital strength: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.

Each capital category has minimum requirements for the following three ratios:

• Tier-1 leverage ratio: This is an institution's core capital (total equity capital with adjustments for unrealized gains and losses on securities, deferred tax benefits, non-qualifying preferred stock and other items) divided by its average total assets.
• Tier-1 risk-based capital Ratio: Since this ratio uses risk-weighted assets as the denominator, it is usually higher than the tier-1 capital ratio. Bank assets are weighted by risk on Schedule RC-R of the Call Report. For example, cash is weighed 0% risk. Performing single-family mortgages have a 50% risk-weighting. Nonperforming loans will have higher risk-weightings. All securities and loans have risk-weightings defined by several factors, including the issuer and agency ratings.
• Risk-adjusted capital ratio: This is the ratio of total risk-based capital to total risk-weighted assets. Risk-based capital is (roughly) tier-1 capital plus loan loss reserves. This is the ratio that most commonly slips below the minimum for an institution to be considered well capitalized under regulatory guidelines.

Capital Ratios and Regulatory Capital Categories

Taking those categories into account, the following are the criteria for determining a bank's capital health:

Well Capitalized

• Core capital to adjusted tangible assets as least 5%
• Core capital to risk-weighted assets at least 6%
• Risk-adjusted capital ratio1at least 10%

Adequately Capitalized

• Core capital to adjusted tangible assets at least 4%
• Core capital to risk-weighted assets at least 4%
• Risk-adjusted capital ratio at least 8%

Undercapitalized

• Core capital to adjusted tangible assets less than 4%
• Core capital to risk-weighted assets less than 4%
• Risk-adjusted capital ratio less than 8%

Significantly Undercapitalized

• Core capital to adjusted tangible assets less than 3%
• Core capital to risk-weighted assets less than 3%
• Risk-adjusted capital ratio at least less than 6%

Critically Undercapitalized

• Tangible equity ratio less than 2%

The tangible equity ratio is an institution's tier-1 capital, plus non-qualifying preferred stock. For all the institutions on our list, the tangible equity ratio equals the tier-1 leverage ratio.

The vast majority of institutions are well capitalized, and many greatly exceed the minimum requirements for a well-capitalized institution.

Out of 8,459 domestic banks and thrifts reporting as of Sept. 30, 2008, all were well capitalized except for 161 institutions.

Even slipping to adequately capitalized is something that institutions try very hard to avoid.

Definitions

The following are abbreviated definitions of Bank Call Report or Thrift Financial Report line items, used in capital ratios.

Abbreviated Definitions:

Tier-1 (core) capital: Total equity capital, less unrealized gains (losses) on available-for-sale securities and cash flow hedges, nonqualifying preferred stock, goodwill and other intangible items.

Tier-2 (supplementary) capital: Capital items disallowed from tier-1 capital, plus loan loss reserves.

Tier-3 capital allocated for market risk: Reported only by certain banks, subject to market risk capital guidelines. It includes capital to support market risk, not credit risk.

Adjusted tangible assets: Average quarterly total assets less disallowed items, including goodwill, servicing assets, deferred tax assets, and other. Further adjustments are made for institutions with financial subsidiaries.

Risk-based capital: The sum of tier-1, tier-2 and tier-3 capital, with deductions for some subsidiaries and international holdings.

Risk-weighted assets: The total of four risk-weighted categories. Cash, U.S. government securities, and other low-risk assets have a 0% weighting. Other securities and loans are carry weightings of 20%, 50% or 100%, depending on guidelines based on issuer type, agency ratings, loan collateral and loan performance.