A Look At Common Equity Tier 1 Capital Ratios For The Largest U.S. Banks

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Investors and regulators around the world have kept a close eye on banks’ common equity tier 1 (CET1) ratio figures over recent years, with the Basel committee prescribing stricter capital requirement norms for the largest global financial institutions. This key metric has been under particularly sharp scrutiny over the last few weeks as the Federal Reserve prepares to release the results of its Comprehensive Capital Analysis and Review (CCAR) for banks. Also referred to as the bank stress tests, this annual exercise by the country’s financial regulator relies considerably on the CET1 ratio figure for each bank.

U.S. banking giants have put in a considerable amount of effort over recent years to prioritize Basel III compliance – on several occasions shrinking profitable operating units to clean up their balance sheets. Investors in the banking sector have also felt the impact of the tighter regulatory oversight, as dividend payouts and share repurchases from the banks have remained low since the economic downturn. And with the Fed adopting capital surcharges for the U.S. banking system that are more stringent than those laid out under the Basel III norms, the banks may also have to delay their capital return plans further in order to pass the stress tests. [1]

But how do these banks fare in terms of existing Basel III requirements? In this article, we highlight the degree to which the six largest U.S. banks have improved their Tier I common capital ratios over the last two years. While all these banks have already surpassed their CET1 ratio targets as proposed by the Basel committee – something they need to achieve by the end of 2019 – some of them are in significantly better shape in terms of capital structure compared to their peers. Notably, JPMorgan is the only bank which falls short of its capital target under the Fed’s more stringent requirements.

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In the wake of the global economic downturn, financial regulators around the world have been working on tighter rules to ensure the sustainability of global banks in the event that such circumstances recur in the future. The Basel III standards formulated by the Basel Committee on Banking Supervision (BCBS) form the crux of the proposed financial sector reforms, with regulators in each country implementing additional controls beyond those laid out under these standards. As a consequence, banks around the globe have diligently worked to meet the stringent guidelines, even though the standards themselves have not yet been finalized. Notably, the common equity Tier I (CET1) capital ratios are most often used as a quick reference to gauge a bank’s capital strength and also to compare them side-by-side. This is the figure we tabulate below to allow for the comparison of the country’s biggest banks.

The figures below have been taken from the quarterly filings for each of the banks since Q3 2012 (the period for which data is available for all the banks) and refer to the pro-forma fully phased-in CET1 ratio figure they report. It should be noted that some of the banks revise their Tier I common capital ratios from time-to-time retrospectively, to account for ongoing modifications in the Basel III standards. Also, the current Basel III norms advocate two different methods for calculating the size of risk-weighed assets (RWA) – the Advanced approach and the Standardized approach. For banks that provide both figures, we have considered the lower of the two figures (as is required by the Basel III rules). The table also includes the CET1 ratio target regulators have set for each of these banks. These are different for each of the banks based on their complexity, global footprint as well as interdependence (see The Basel III Challenge For Banks: Why Extra Capital Requirements?). While “Target (Basel)” represents the CET1 ratio target for each bank proposed by the Basel committee, “Target (Fed)” represents our estimates for the target ratios under consideration by the Fed as we detailed in our article Understanding The Fed’s Proposed Capital Surcharges For The Largest U.S. Banks.

Q4’12 Q1’13 Q2’13 Q3’13 Q4’13 Q1’14 Q2’14 Q3’14 Q4’14 TARGET (Basel) TARGET (Fed)
Morgan Stanley 9.50% 9.70% 9.90% 10.80% 10.50% 10.20% 10.70% 11.77% 10.67% 8.50% 9.50%
Citigroup 8.74% 9.34% 10.03% 10.50% 10.59% 10.46% 10.58% 10.66% 10.58% 9.00% 10.50%
Wells Fargo 8.18% 8.39% 8.55% 9.54% 9.78% 10.04% 10.09% 10.45% 10.45% 8.00% 9.00%
Goldman Sachs 8.80% 9.00% 9.30% 9.10% 9.17% 9.30% 9.40% 10.00% 10.24% 8.50% 9.50%
JPMorgan 8.74% 8.86% 9.33% 9.33% 9.50% 9.58% 9.79% 10.11% 10.18% 9.50% 11.50%
Bank of America 9.25% 9.52% 9.60% 9.00% 9.06% 8.99% 9.55% 9.53% 9.64% 8.50% 9.50%

Morgan Stanley leads the U.S. banking giants with a CET1 figure of just under 10.7% at the end of Q4 2014. The considerable difference in this figure over the Q2 2014-Q4 2014 period can be attributed to changes in the manner the investment banking group valued its capital as well as its asset base. Morgan Stanley’s CET1 ratio has benefited over the years from its decision to remain stingy with returning cash to shareholders – instead focusing on acquiring 100% of Smith Barney from Citigroup. Morgan Stanley’s long term strategy of cutting down on the capital-intensive fixed-income trading business has also helped reduce the size of its risk-weighed assets (RWA), which in turn has given the CET1 figure a boost. Morgan Stanley’s CET1 figure at the end of Q4 2014 was a good 217 basis points (2.17% points) higher than the target of 8.5% it needs to achieve by 2019. Notably, this means that the investment bank will not have to worry too much about working on its capital ratios even if the Fed decides to impose a 10.5% capital requirement target on the bank.

Citigroup comes in at second with a CET1 figure of just under 10.6%. The bank’s decision to shift non-performing and non-core assets into the Citi Holdings division in 2009, and to subsequently divest them, has paid off quite well. This has helped the bank systematically reduce the size of its risk-weighed asset (RWA) base, which forms the denominator in the calculation of the core Tier I capital ratio. While the geographically diversified banking group has a comfortable buffer of 158 basis points (1.58% points) in terms of Basel committee recommendations, the Fed’s proposed target nullify this buffer almost entirely. Wells Fargo fares much better in this regard with a buffer of almost 250 basis points (2.5% points). The U.S.-focused banking giant has improved its capital ratio figure steadily over the years purely through organic growth in its earnings.

JPMorgan stands out as being the only bank here which has yet to meet the Fed’s CET1 ratio target. The diversified banking group faces the highest capital requirements among U.S. banks, and is estimated to require roughly $20 billion in Tier 1 capital to meet the Fed’s requirement. JPMorgan has already emphasized on the fact that it will not make any major changes to its business model to achieve the goal – looking to build its capital reserves gradually over the coming years by relying on its strong earnings figures.

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Notes:
  1. Fed proposes extra capital cushion for 8 big U.S. banks, Reuters, Dec 10 2014 []