Q3 2014 U.S. Banking Roundup: Common Equity Tier 1 Capital Ratios

In early September, the Federal Reserve hinted at implementing stricter capital requirements for the U.S. banking system than those laid out under Basel III norms, with banks that depend considerably on short term funding expected to attract a higher capital surcharge. ^[1] This did not bode well for U.S. banking giants, who have had to 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. Further increases to common equity tier 1 (CET1) ratio requirements will force the banks affected to find more ways to reduce their risk-weighed asset bases through implementing additional changes to their business models. The banks will also have to delay their capital return plans, and may even have to issue more shares to make up for any capital shortfalls.

So how do these banks actually 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 target – 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.

See our full analysis for Bank of America | Citigroup | JPMorgan | Wells Fargo | Goldman Sachs | Morgan Stanley

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 banking industry regulators for 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 the 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?). Finally, the buffer mentioned here is the difference between the target and the bank’s CET1 ratio at the end of Q2 2014.

Morgan Stanley leads the U.S. banking giants with a CET1 figure of 11.8% at the end of Q3 2014 – a considerable effort, considering that the banking group has improved the figure by almost three percentage points within eight quarters. The ratio has benefited from the investment bank’s 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. The bank also ranks at the top in terms of achieving the highest capital buffer over and above the mandatory target set for it by regulators. Morgan Stanley’s CET1 figure at the end of Q3 2014 is a good 327 basis points (3.27% points) higher than its target of 8.5% that needs to be achieved 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 an additional capital surcharge on the bank. ^[1]

Citigroup comes in at second with a CET1 figure of just under 10.7%. The bank’s decision to shift non-performing and non-core assets into the umbrella 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 166 basis points (1.66% points), 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 having the lowest capital buffer over Basel III requirements. The banking group faces the highest capital requirements among U.S. banks. As it is not looking to make any major changes to its business model, it clearly intends to build its tier 1 capital gradually over the coming years by relying on its strong earnings figures.

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1. Fed to Hit Biggest U.S. Banks With Tougher Capital Surcharge, The Wall Street Journal, Sept 8 2014 [↩] [↩]