Big Banks: Capital Requirements ‘Manageable,’ ‘Less Than Ideal’

Credit Suisse analyst Susan Roth Katzke and team argue that changes to the capital requirements for big banks–Bank of America (BAC), JPMorgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC) among them–will be “largely manageable but less than ideal.” They explain:

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We expect the Fed to publish its proposal this summer, with that proposal including incorporation of the full, Method 2 global systemically important banks surcharge into CCAR stressed minimums as well as offsets including but not limited to curtailment of capital distribution in the stressed periods. Further offsets could include refinement to the market shock and counterparty default risk assessments; this potential is more difficult to assess/quantify. We expect implementation to be targeted for [Comprehensive Capital Analysis and Review, or CCAR,] 2018, though payout ratios will be influenced as early as CCAR 2016.

At the high end, ~200bps of additional required CET 1. Our assessment of the cost of likely CCAR changes, incorporating a “cost of stress”, limited capital actions andGlobal systemically important banks Method 2 surcharges, translates to an incremental 100-200 bps of required CET 1 for Bank of America, Citigroup,JPMorgan Chase andWells Fargo (assuming CCAR is then the binding constraint on capital and relative to current non-stressed required fully-phased in Basel 3 CET 1 minimums). Our analysis uses the 2015 DFAST cost of stress as a starting point (for some that cost will be higher, for others lower, in 2016 and beyond) and relies on existing forecast RWA changes and capital actions…

With respect to the CS Large Cap Bank Stocks The CS Large Cap Banks are ~25% above their mid-February lowsbut still down 7% year to date and trading at a below average 1.0x price/book value. There’s upside to be realized, in our view. A sustained rally relies on visibility into an extended business cycle (positive U.S. and global GDP growth) and with that, manageable credit cost increases and improved capital markets prospects. We’re late in the cycle; there will be volatility. We put the upside potential at 15-20% for our recommended names, JPMorgan Chase, Bank of America, Citigroup,Wells Fargo and Goldman Sachs Group (GS).

Kroll Bond Rating Agency’s Chris Whalen argues that capital requirements miss the point:

Kroll Bond Rating Agency notes that since the 2008 financial crisis and the passage of the Dodd-Frank legislation two years later, global financial regulators have been pushing a deliberate agenda to increase the capitalization of large banks. Despite the fact that the 2008 financial crisis was not caused by a lack of capital inside major financial institutions, raising capital levels has become the primary policy response among many of the G-20 nations.

KBRA believes that using higher capital to change bank profitability and, indirectly, corporate behavior is a rather blunt tool for the task of ensuring the stability of financial markets. Part of the problem with using capital as a broad prescription for avoiding rescues for large financial institutions, aka too big to fail or TBTF, is that this approach explicitly avoids addressing the actual cause of the problem, namely errors and omissions by major banks that undermined investor confidence.

One of the key fallacies embraced by regulators and policy makers is the notion that higher capital levels will help TBTF banks avoid failure and, even in the event, the failure of a large bank will not require public support. KBRA believes that there is no evidence that higher levels of capital would have prevented the run on liquidity which caused a number of depositories and non-banks to fail starting in 2007.

Shares of Bank of America have fallen 1.7% to $14.18 at 2:22 p.m. today, while Citigroup has declined 1.1% to $45.06, Wells Fargo has dropped 1.7% to $49.13, JPMorgan Chase has slipped 0.8% to $64.72, and Goldman Sachs Group is off 0.9% at $153.23.


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