Tier I ratio is the main indicator of capital strength
Tier-I capital ratio, also called Tier I ratio, is the most important indicator of capital strength and risks in banking. Tier I ratio is a bank’s core equity as a percentage of risk-weighted assets. A minimum Tier I capital is a regulatory requirement.
Tier I ratio is above the regulatory requirement
Regulations requires Capital One (COF) to maintain a Tier I ratio of at least 8%. Capital One is well capitalized on that front. The bank maintained a Tier I ratio of 12.16% at the end of 4Q14. Years ago, Capital One used to hold a high level of capital. This was because the bank primarily had credit card loans. These loans are unsecuritized. So, as a measure of conservativeness, the bank held high levels of capital.
Diversified loan book led to lower capital
However, the loan book diversified in recent years. This made it necessary to shed capital. The bank took a calibrated approach to shed the excess capital. It gradually decreased the capital because the loan mix changed. Even after shedding the capital, the Tier I ratio remains higher than its peers. This is because credit card loans still form the largest part of the loan book.
Other banks—like Wells Fargo (WFC), U.S. Bank (USB), and PNC Bank (PNC)—hold a lower level of capital than Capital One. Capital One is adequately funded for growth in the coming years. A fall in the credit card heavy loan mix will free up capital for Capital One in the years ahead. Most of the banks in the Financial Select Sector SPDR (XLF) aren’t capitalized as well as Capital One.