Citigroup Inc (C), Bank of America Corp (BAC): What a Stable Banking System Means for Your Banking Stock

The U.S. banking sector is facing more and more stringent capital requirements, the latest of which is the two-fold rise in the leverage ratio minimum to 6%. While some meet the proposed requirements, others don’t. Therefore, it’s unlikely that the Fed will set a minimum leverage capital target that significantly disadvantages the U.S. banks relative to their international counterparts. Nevertheless, I don’t expect a 6% level to be a more meaningful constraint on capital return for banks in the U.S.

Proposed requirements

Bloomberg reported that the Fed and the Federal Deposit Insurance Corporation (FDIC) are aiming to raise the leverage ratio minimum to 6%, which will be twice the international banks will be required to hold under the Basel III requirements.

Unlike the Tier 1 common ratio, which is based on risk-weighted assets, the leverage ratio is based on total assets. The proposed leverage ratio will incorporate certain off-balance sheet exposures such as derivatives and commitments.

Do the banks meet the proposed requirements?

Citigroup Inc (NYSE:C)

Among the large cap banks, Citigroup Inc (NYSE:C) and Bank of America Corp (NYSE:BAC) have the least leverage ratios of 4.6% and 5.1%, respectively. Both have over $650 billion of estimated off-balance sheet assets which add up to calculate the Basel III Tier 1 leverage ratio. In contrast, Capital One Financial Corp. (NYSE:COF) has the highest leverage ratio of 7.7% with the lowest amount of estimated off-balance sheet items ($52.7 billion). On average, the large cap banks have a 6.1% Basel III Tier 1 leverage ratio.

Under Basel I regulations, current assets like cash, Treasuries, and other assets receive a 0% risk-weighting. If these asset categories are eliminated from the calculations of total assets in the leverage ratio under the proposed regulations, Bank of America Corp (NYSE:BAC) would be pushed above a 6% leverage ratio. Citigroup Inc (NYSE:C) would be pushed to a 5.9% leverage ratio as of March 31, 2013.

What could they do to meet the proposed requirements?

Given the substantial increase in capital over the last few years, I believe the banks will engage in balance sheet management to meet the requirements. This, coupled with internally generated capital, should be sufficient to meet the proposed 6% leverage ratio target. Balance sheet management means the constraints banks put on their liquidity coverage ratio, net stable funding ratio, capital conservation buffer, and asset liabilities ratios.

Also, contrary to popular opinion, analysts at Credit Suisse see no dividend cuts by these large cap banks nor capital raising if the minimum leverage is set at 6%. Further, if the proposed leverage ratio is implemented, banks like Citigroup Inc (NYSE:C) and Bank of America Corp (NYSE:BAC), that fall short, would need to reduce their assets, including their off-balance sheet assets, by 17% on average.

Among other ways for Citigroup Inc (NYSE:C) and Bank of America Corp (NYSE:BAC) to cope with the proposed leverage ratio standards include suspension of their dividends. One consequence of the proposed regulations might include lower earnings potential for Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) as banks continue to raise internal capital. While banking stocks are not famous for their dividend yields, they still form part of the total returns.

Bank of America Corp (NYSE:BAC) offers a dividend yield of 0.31% on its quarterly dividend rate of $0.01 per common share. Citigroup Inc (NYSE:C) has a similar dividend rate and yields 0.08%, while Capital One Financial Corp. (NYSE:COF) offers a dividend yield of 1.9% on its dividend rate of $0.30 per common share. Since Capital One Financial Corp. (NYSE:COF) already meets the requirements, suspension of its dividend is highly unlikely.

Conclusion

Given the substantial increase in capital over the last few years, larger banks in the U.S. are expected to pursue balance sheet optimization to meet new leverage requirements. Further, it’s believed that banks will not cut their dividends and nor will they raise more capital to meet proposed requirements. That said, I believe the Fed will not introduce regulations that will be disadvantageous to the U.S. banks.

The article What a Stable Banking System Means for Your Banking Stock originally appeared on Fool.com and is written by Red Chip.

Red Chip has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America and Citigroup Inc (NYSE:C). Red is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

10 Most Influential Papers In Economics

Top 8 Biggest Charities in the US

10 Worst Celebrity Career Moves Ever

Top 10 Best Paid Tennis Stars in the World

10 Cities with High Demand for Nurses

6 of the Worst Greeting Card Messages Ever Crafted

6 Ways to Make Money in ArcheAge and Build Your Empire

10 Foods To Eat To Lower Cholesterol Levels

The 10 Most Hated Television Characters of All Time

The 30 Worst Halloween Costume Ideas Ever Brought to Horrible Life

10 Vocational Skills in Demand Today with Jobs Waiting to be Filled

10 Best Places to Visit in Central and South America

The 10 Greatest Empires in History Which Nearly Conquered the World

The 6 Cheapest Boarding Schools In America 2015

5 Clear Reasons LoL is Better than DotA, Continues to Rule MOBAs

The Only 9 Teams with a Chance to Win the Super Bowl

The 15 Most Common Phobias in America that Induce Fits of Panic

Top 6 Least Expensive Tourist Destinations in 2014

Jim Goetz, Peter Fenton, Jim Breyer: Top 6 Venture Investors for 2014

Top 15 Billionaires in 2014

5 Pitfalls To Avoid When Buying a Franchise

Top 20 Medical Schools in the US – 2014 Rankings

4 Business Strategies that Turned Jamie Oliver into the World’s Richest Chef

6 Qualities That Make You A Good Team Player

10 High Paying Seasonal Jobs in America this Holiday Season

The 10 Busiest Shipping Lanes in the World

5 Most Valuable Brands in China

The 10 States with Highest Substance Abuse Rates Crippling Their Populace

The Top 10 Things to Do Before You Die That Will Echo for Eternity

The 10 Best Selling Items on Etsy

Top 10 Things to Do in Tokyo, the Greatest City in the World

10 Mistakes on Social Media that Can Harm You and Will Probably Get You Canned

The 10 Best Cities to Find Jobs in 2014

The 10 Most Controversial Songs Of All Time to Hit (and get Banned from) the Airwaves

The 20 Biggest IPOs in US History

The 10 Best Places to Visit in Mexico that Are Beautiful and Safe

7 Bad Habits that Age You Beyond Your Years

The 40 Best Fortune Cookie Sayings That Will Leave You Bemused, Befuddled, or Beguiled

10 Foods to Eat Before a Workout to Make Every Drop of Sweat Count

The 5 Best Documentaries On Netflix You Must See

The Most Heartwarming and Inspirational Story Of This Halloween Season, It Will Make You Cry and Jump For Joy

10 Best Party Songs of All Time to Bring the House Down With

5 New World Order Conspiracy Theories that Will Strangle the World

The 10 Highest Rated Movies of 2014

The 10 Largest Container Shipping Companies in the World

The 10 Largest Armies in the World: Who Should We Be Afraid Of?

Best Warren Buffett Quotes on Money You Need to Hear

The 10 Highest Suicide Rates by Profession

The 20 Most Underrated Movies of All Time

The 10 Fastest Growing Companies in America

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!