First Student Bank Case Study

Problem I:
1. Yes, the First Student Bank should comply with the risk-based capital rules. This is because, these rules is mandatory for financial banking and non-banking institutions and is supervised by the Federal Reserve.
2. The common equity capital of First Student Bank is $5,000,000.
Tier 1 Capital = Common Equity + Non-cumulative Perpetual Preferred Stock
Tier 1 Capital = 5,000,000 + 5,000,000 = $10,000,000
3. Total Capital = Tier 1 Capital + Tier 2 Capital
Total Capital = 10,000,000 + 7,000,000 = 17,000,000
4.
Assets Category 1 Category 2 Category 3 Category 4
Cash 100
T-bills 190
T-bonds 30
Repos 10
Tuition loans 500
Home mortgages
Building and furniture 100 110
Loan loss reserve (40)
Total 320 100 580
To decide whether First Student Bank has an adequate Tier 1 capital and total capital we need to compare the requirement of each with the current amounts.
Required Tier 1 Capital = 0.04 * 1,595,000,000 = $63,800,000
Required Total Capital = 0.08 * 1,595,000,000 = $127,600,000
The current Tier 1 capital and total capital are 10,000,000 and 17,000,000 respectively, therefore the First Student Bank is severely undercapitalized.
Problem II:
The growth rate at which the bank will grow is the ratio of total capital to total assets and therefore equal to 30 / 500 = 0.06 = 6%.
1. We know the relationship linking the sources of capital is:
∆TA/TA1 = [ROA (1-DR) + ∆EC/TA2] / [EQ1/TA1]
By substituting the numbers given in the question, we find that bank's ROA is equal to:
0.15 = [ROA (0.70) + 0] / 0.06 → ROA = 1.29%.
2. By substituting the numbers given in the question, we find that bank's dividend payout ratio should be:
∆TA/TA1 = [ROA (1-DR) + ∆EC/TA2] / [EQ1/TA1]
0.15 = 0.0085(1-DR) + 0] / 0.06 → DR = 0.0588 = 5.88%.
So the bank has to decrease the dividend payout ratio from 30% to 5.88%. in other words, the bank has to retain more earnings and pay less in dividends. This will grant the bank organic growth without the need for external