Sunday, November 29, 2009

Bank Tier 1 Ratios

On the 11/28/2009 show I mangled a Tier 1 commentary and may have ended up implying the opposite of what I meant as I was rapid firing information.

A Tier 1 ratio can be in two forms: 1) a capital ratio in which it is core equity to core capital or total assets or 2) a risk capital ratio in which it is core equity to total risk weighted assets.  It is a measure of financial strength and the higher the ratio  (2:10 is 20%) the better.

The example and information I was using on the show should have been to remember that when Lehman Brothers failed it had a Tier 1 ratio of 11%.  The median Tier 1 ratio for large and mid-cap banks is in the range of 8.4 to 10%, which is lower (riskier) than Lehman when it failed.  That means many banks are lower (worse). The higher the ratio/percentage the better

The FED/Treasury stress tests set a minimum of 4% for Tier 1 in determining tangible common equity, which yields a lower percentage than Tier 1 core equity.  What would the minimum have  been for core equity Tier 1? They should have included the core equity Tier 1 for comparison.  See this older post from Baseline Scenario for an explanation of tangible common equity.  Also banks have not had to mark to market toxic assets and some do not even include toxic assets which are government insured on their balance sheets, which brings a significant question of how accurate and comprehensive the risk weighted assets were.

I had a lingering feeling from the show that I misspoke and botched a clear conveyance of the magnitude of how fragile the current situation really is.

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