how to decide on the risk-based assets and risk-adjusted capital

[bestmarcus]

David
i still confuse on some concept about this topic




Asset Liabilities and Equity
Cash and Reserves $20M Deposits $850M

Treasury Securities 75 Subordinated Debt 15
Mortgages 740 Common Stock 10
Fixed Assets 70 Retained Earnings 30
Total 905 905

Off-Balance-sheet items (assume 50% risk-based weights)
Long-term loan Commitments $500 Million
Interest Rate Swap Agreement $100 Million

$50 Million of the mortgages are in default


Q1 is the tier 1 and 2 capital right?

Tier 1 capital (in $Million)
+Common stock 10
+Retain earning 30
+Cash and reserves 20
+Treasury Securities 75
Net Tier 1 capital 135


Tier 2 capital (in $Million)
Subordinated debt 15
Net Tier 2 capital 15

Q2 I want to know how to decide on the risk-based assets and risk-adjusted capital

Marcus

 

[David Harper CFA FRM]

Hi Marcus,

Tier 2 looks correct to me, but not Tier 1 because that summation mixes assets (that already contribute to equity) with equity; e.g., the cash = 20 and treasuries = 75 are being double-counted. It is maybe helpful to see the balance sheet as Equity = Assets - Liabilities; equity = net assets after liability claims. If you added $50 cash to this balance sheet, then both cash and common stock are +50 so you can see why they should not both be counted. Essentially, Tier 1/2 capital is concerned with the right-hand side of balance sheet. (they are "buffers" against declines in asset values on "left hand" side of B/S). So, here, I'd get Tier 1 = 40 (30+10) (note: I may be technically inexact in relation to reserve accounts, but I *think* any reserves have to be liabilities but i suppose they could be contra-asset accounts...)

Re Q2, with going into detail, suggest you see the 8% basel ratio as [right hand side equity and equity-like residual claim; i.e., a financing metric] / [adjusted left hand side asset]. The generic ratio is capital/assets and there are vritually unlimited flavors of capital/assets.
The baseline guys are real good at this, see http://baselinescenario.com/2009/02/24/tangible-common-equity-for-beginners/#more-2683

I'd offer that maybe the conceptual starting point is: 1. see that common equity is a residual; what is left after subtract liability claims from assets. Okay, so that is a generic [common equity]/[total assets] ratio. But it's narrow book definition. Now the Basel def has many particular rules, etc, but they are basically adjusting the numberator for "buffer" and risk-adjusting the denominator.

David

 

[David Harper CFA FRM]

Hi Marcus,

I just checked the specific Basel (long-winded definition) of Tier 1 and I would stand by my conceptual starting point: common equity (as a residual; including retained earnings). Then a list of adjustments which do include asset and liability accounts but they are *adjustments* to reverse decisions in GAAP accounting; goodwill is an asset but it's intangible so it gets deducted (and this is tantamount to adjusting the equity down on the right hand side). So there will be reversals for assets and liabilities, but as i said above, you wouldn't add cash or securities straightaway because (here is the difference they already credit equity. In fact, as I look at the Tier I expanded defintion, I am inclined to view it as nothing more than common equity + a set of reversals to undo specific accounting rules that net-net aim to disagree with the accounting and subtract out dubious buffer (goodwill) and include solid buffer (minority interest)

David

 

[bestmarcus]

David
http://www.mufg.jp/english/ir/annualreport/2009mufg-half-baselii/pdffile/baselii09half.pdf
please see page 3 from the link
why do mufg add treasury stock in the tier 1 core capital ?
but i cannot count treasury security in the tier 1?
WHY?

Marcus

 

[David Harper CFA FRM]

Marcus - two different things, the treasuries in your question are riskfree assets. Treasury stock in the disclosure is (probably) the company's own stock that has been re-purchased (see how it is negative, it's not adding; it's a contra equity account that is reducing shareholder's equity). If company buys treasuries, then exchanges cash for another asset (that is nearly cash): no balance sheet shrinkage. If company repurchases it's shares, spends cash to reduce common equity: balance sheet shrinks. The "treasury stock" is more like an accounting deduction to equity; it is not getting included in Tier 1. I only took quick look but the first 6 lines of this mufg are basically just i. common equity and ii. retained earnings but broken out by accounts. David