These Banks Need to Raise Capital Quickly
05/27/08 - 12:21 PM EDT
Philip van Doorn
If you're wondering whether your bank has enough capital, keep reading.
Capital adequacy is the most important topic for bankers as the real estate credit crisis continues. So far this year there have been three bank failures, the most recent being ANB Financial, which was considered "critically undercapitalized" by regulators, and was closed down on May 9. Several other institutions with capital adequacy concerns have been acquired recently, or are making merger deals as we speak. While most depositors are protected by FDIC insurance, chances are you know someone affiliated with a business or municipality (such as a school district) with large deposits in a local bank. Since most of these deposits are uninsured, it's important to monitor bank ratings using TheStreet.com's Ratings Screener. In better times than these, banks and S&Ls walk a fine line. If they hold too little capital, their solvency could be at risk. If they hold too much capital, their return on equity suffers, which irritates investors. Threats to capital levels include rapid expansion and credit quality problems. When banks feel they are holding too much capital, they increase their dividends and/or stock buybacks. As we have seen during the unfolding crisis, some banks, such as National City(NCC Quote - Cramer on NCC - Stock Picks) and Corus(CORS Quote - Cramer on CORS - Stock Picks) suffered from bad timing, with significant stock buybacks and generous dividends just before the real estate crisis hit them hard. While it will be at least another week until we have finalized March 31 data for all of the nation's banks and S&Ls, TheStreet.com Ratings has identified 113 institutions that were considered below well-capitalized per regulatory guidelines as of quarter-end. That's up from 90 last quarter, and 71 in March 2007. An institution generally needs to maintain a leverage ratio of 5% and a risk-based capital ratio of 10% to be considered well-capitalized. These ratios need to be 4% and 8% to be considered adequately capitalized. Leverage Ratio This is also known as the "tier 1 leverage ratio." Tier 1 capital (or core capital) is the institution's total equity capital, less unrealized gains on securities held-for-sale, some preferred stock and goodwill. The leverage ratio is calculated by dividing tier 1 capital by an institution's average total assets. Risk-based Capital Ratio This is also known as the "total risk-based capital ratio." Risk-based capital includes tier 1 capital, along with tier 2 (essentially the institution's loan loss reserves) along with tier 3, which is capital set aside for market risk and is only required for some banks. To calculate the ratio, risk-based capital is divided by risk-weighted assets. Banks and thrifts come up with this figure by assigning risk-weightings to all of their assets. To provide a few examples, cash has a zero-weighting. Certain mortgage-backed securities have a 20% risk weighting. Performing mortgages have a 50% risk-weighting. Nonperforming mortgages have a 100% risk-weighting. The full calculation of risk-weighted assets is much more detailed, but the idea is that the figure represents the risk of an institution's asset portfolio and reflects its loan quality. This is why the risk-based capital ratio is the one most likely to slip below the well-capitalized threshold.
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