A NEGATIVE FOR BIG MULTINATIONAL BANKS / BARRON´S MAGAZINE ( HIGHLY RECOMMENDED READING )

Investors' Soapbox PM


MONDAY, JUNE 6, 2011

A Negative for Big Multinational Banks


A Fed official's speech was negative for Bank of America, Citi and JPMorgan.

Sterne, Agee & Leach




The Federal Reserve cast an early warning shot over required bank-capital levels suggesting Basel III does not go far enough to adequately contain systemic risk. In a speech on Friday, Federal Reserve governor Daniel Tarullo suggested "too big to fail" institutions could be ordered to hold minimum capital levels well above current Basel III minimums (7% Tier 1 Common).


The Fed speech cast an early warning over required systemically important financial institution (SIFI) buffers and prudential capital standards legislated under Dodd-Frank—far worse than current consensus expectations. Dodd- Frank designates all financial institutions more than $50 billion as systemically important (35 bank-holding companies) and requires the Fed to develop capital standards for these companies by January 2012.


The speech was particularly negative for the large multinational banks that have significant capital markets exposure and that serve a primary role in the global-payments arena, including Bank of America (ticker: BAC), Citigroup (C) and JPMorgan Chase (JPM).


Our primary takeaways from the Governors' speech are: 1) capital buffers likely to be higher-than-expected; 2) required capital buffers likely geared toward common equity versus hybrids; 3) introduction of progressive capital scale based on size and complexity; 4) ensure congruent with international capital requirements; 5) capital requirement likely derived from expected impact model, or required capital necessary to neutralize loss created by SIFI failure on financial system (current Fed analysis suggested this could equate to as much as 14% Tier 1 common for certain institutions versus 7% current minimum under Basel III).


While a 14% capital standard seems pretty extreme to us—even by regulatory standards—it is important to note that the SIFI standards are far from being finalized. Moreover, we are hard pressed to believe that certain aspects of the Governor's capital theory and logic are widely held views by other members of the board or its staff.


We note that Tarullo is the only Governor (excluding Bernanke) who lacks practical banking and regulatory experience—so it's hard for us to get too worked up over the potential for 14% capital at this stage.


In terms of the expected capital time frame, we understand that the Financial Stability Board (FSB) will be meeting over the course of summer in Europe in preparation for a recommendation to the Bank for International Settlements (BIS) and the Basel committee in fall—in time for formal recommendation to G-20 later this fall. This process is very similar to the year-ago period and the Basel III adoption and process.


This process is likely to coincide with a U.S. notice and comment period for the Fed's proposed rulemaking on enhanced prudential standards for SIFIs—which is due by January 2012. While certain banks and investors continue to speculate on required capital buffers, our regulatory sources continue to confirm the fact that none of the banks have been provided with any details on SIFI to date.


It is our understanding that the Fed, like the international community, continues to struggle over the definition and concept of "systemically important." At the same time, work continues to focus on the liquidity requirements and phase two of the comprehensive cost and requirement (CCAR) program.


While it's difficult to handicap the outcome of the SIFI requirements, we continue to believe that the Fed will likely publish a capital standard, or minimum—consistent with Basel III guidelines.


However, each company will likely be held to different SIFI requirements—which will vary over time—in line with regulatory expectations given risk profile, economic conditions, etc.


Importantly, we do not believe the specific buffers will be made public. In effect, we believe this will require the banks to run well above any published minimum or standard over time—but will allow flexibility to raise dividends, buy back stock, etc.


Long term, we believe it's actually the excess capital theme and onerous capital requirements that will eventually spark a return to traditional mergers and acquisitions—particularly among the large to mid-sized regional banks.


Our belief is that "well capitalized" banks will receive more regulatory relief for pursuing acquisitions versus traditional buybacks and dividends (i.e., M&T Bank (MTB)).


-- Todd L. Hagerman


-- Robert Greene