Q2 2015 U.S. Banking Review: Common Equity Tier 1 Capital Ratios

-13.81%
Downside
57.96
Market
49.96
Trefis
WFC: Wells Fargo logo
WFC
Wells Fargo

Relevant Articles
  1. Is Wells Fargo Stock Fairly Priced?
  2. Where Is Wells Fargo Stock Headed?
  3. Wells Fargo Stock Is Trading Below Its Fair Value
  4. What To Expect From Wells Fargo Stock In Q4?
  5. Is Wells Fargo Stock Fairly Priced?
  6. What To Expect From Wells Fargo Stock?

Improved operating results for major U.S. banks, coupled with continued efforts by the banks to clean up their balance sheets, have resulted in a sizable increase in common equity tier 1 (CET1) ratio figures for the industry compared to the end of 2014. While the country’s largest banks had already surpassed their CET1 targets as proposed by the Basel committee in 2013, some of them are in significantly better shape in terms of capital structure compared to their peers. This disparity is particularly important when we consider the more stringent requirements that are currently being worked on by the Federal Reserve.

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. The systemically important financial institutions (SIFIs) have had to prioritize Basel III compliance in recent years in order to secure regulatory clearance for higher capital return plans to investors. By taking stock of where these banks stand now in terms of compliance with capital ratio requirements, we try to estimate how much more work they need to put in before they can begin returning cash to shareholders at the levels seen prior to the recession.

See our full analysis for Bank of AmericaCitigroupJPMorganWells FargoGoldman SachsMorgan 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 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 over the last eight quarters 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 that regulators have set for each of these banks. 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.

Q3’13 Q4’13 Q1’14 Q2’14 Q3’14 Q4’14 Q1’15 Q2’15 TARGET (Basel) TARGET (Fed)
Morgan Stanley 10.80% 10.50% 10.20% 10.70% 11.77% 10.67% 11.57% 12.52% 8.50% 9.50%
Citigroup 10.50% 10.59% 10.46% 10.58% 10.66% 10.58% 11.06% 11.37% 9.00% 10.50%
JPMorgan 9.33% 9.50% 9.58% 9.79% 10.11% 10.18% 10.63% 11.03% 9.50% 11.50%
Goldman Sachs 9.10% 9.17% 9.30% 9.40% 10.00% 10.24% 10.64% 11.01% 8.50% 9.50%
Wells Fargo 9.54% 9.78% 10.04% 10.09% 10.45% 10.45% 10.54% 10.54% 8.00% 9.00%
Bank of America 9.00% 9.06% 8.99% 9.55% 9.53% 9.64% 10.08% 10.35% 8.50% 9.50%

Morgan Stanley significantly widened its lead over other U.S. banks in terms of CET1 figures – making it one of the best-capitalized banks in the world. Morgan Stanley’s long-term strategy of focusing on wealth management operations, and cutting down on the capital-intensive fixed-income trading business, has 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 Q2 2015 was a good 402 basis points (4.02%) higher than the target of 8.5% it needs to achieve by 2019. This is why we expect Morgan Stanley to report the largest hikes in investor payout among U.S. banking giants in the coming years.

While Citigroup’s CET1 figure is a comfortable 237 basis points (2.37% points) higher than the level recommended by the Basel committee, this buffer is less than one percentage point higher than the Fed’s proposed target. This will likely force Citigroup to curtail its capital distributions for at least one more year before it can initiate a large share buyback plan. JPMorgan has done well over the last two quarters to grow its CET1 figure purely on the basis of operating results; the diversified banking group faces the highest capital requirements among U.S. banks, and is the only one to fall short of the 11.5% target figure proposed by the Fed. However, the momentum this year makes it very likely that JPMorgan will achieve this goal by the end of 2015.

The chart below details the trend in the CET1 ratio figure for each of these banks since Q3 2012 – the period for which data is available for all the banks.

CET1_15Q2

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research