First Republic Bank (FRC): The Rising Star in the Banking Industry

Page 1 of 2

At the moment, banks may be one of the best opportunities for investors. During the post-crisis period, banks have delivered the worst worldwide shareholder returns out of all industries. Though many banks are back on track, their prices are still depressed due to shattered investor confidence. This undervaluation could provide investors with a great opportunity to earn a higher return as the banking sector revives.

Regulatory reforms

Banks are highly sensitive to regulatory risk, as new regulations can bring along material costs.

The Federal Reserve (Fed) has been reconsidering key capital adequacy requirements since the financial crisis hit the U.S. Weaknesses became obvious in the recession, leading many to file for bankruptcy. On July 2, Federal Reserve Board approved new regulatory reforms that help in enabling banks to maintain a strong capital base. This will better equip financial institutions to continue lending to creditworthy households and businesses even after absorbing unforeseen losses and during recessions.

My report focuses on analyzing the implications of these changes in key capital rules for banks. I applied a P/E stock screen and chose three undervalued banks: U.S. Bancorp (NYSE:USB), Citigroup Inc. (NYSE:C), First Republic Bank (NYSE:FRC) and one overvalued bank; Bank of America Corp (NYSE:BAC), for my analysis.

Change in capital requirements: is it a wake-up call for banks?

As a result of the revised regulatory framework, U.S. banks will now hold an increased amount of capital. Although many banks are in compliance with the new rules, the Fed anticipates that approximately 100 banks will have to raise $4.5 billion by FY19 to meet the set of laws.

Tier 1 Capital

The statute raised the bar of minimum ratio requirement of tier 1 capital to risk-weighted assets from 4% to 6%.

Source: Company Financials, Form 10-K

All four banks are expected to remain unaffected by the new tier 1 capital requirements as they had sufficiently higher capital cushions. Citigroup Inc. (NYSE:C) and First Republic Bank (NYSE:FRC) have the highest buffer of tier 1 capital at 14.06% and 13.27%, respectively.

However, the total capital requirement against risk-weighted assets remains unchanged at 8%, as stated under the present Basel III framework.

Common equity tier 1

To be inline with the international Basel framework, the rule included a new fundamental minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5%. Considering the quality aspect, common equity tier 1 capital is the most loss-absorbing form of capital. Thus, the higher it is, the more financially strong a bank is.

Though for now, all banks have a strong footing in this area, with Citigroup reporting the highest ratio at 12.67%. U.S. Bancorp (NYSE:USB) had the lowest ratio at 8.1%. Bancorp’s net interest margin declined to 3.58% in FY12 compared to 3.65% in FY11. If the trend continues, the capital level may fall below the minimum requirement. In that case, Bancorp should rebuild it through raising private capital in the market or reduce discretionary distributions of earnings — i.e., reduce dividend payments, share repurchases and staff bonus payments. The distribution constraints imposed on banks increase as the banks’ capital levels approach the minimum requirements.

Leverage ratio

The regulatory framework also incorporates a minimum leverage ratio of 4% for all banking institutions. Leverage in banking is the ratio of lending to equity. First Republic Bank (NYSE:FRC) had the highest leverage ratio reported in FY12 at 9.32%, followed by Bancorp at 9.2%.

Besides, the statute now also requires the reporting of new minimum supplementary leverage ratio that considers off-balance sheet risk exposures, specifically for large internationally active banks. During 2007-08, many banks were lending out more and more funds without raising any extra. They were able to escape the regulatory system by using off balance sheet vehicles. Thus, the new rules specifically focus on addressing this issue.

Page 1 of 2
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. Our beta is only 1.2 (don't click this link if beating the market isn't important to you).

Lists

On the Move: The 10 Fastest Growing Businesses in 2015

Fast Money: The 10 Highest Paying Fast Food Restaurants

Mixing It Up: The 14 Best Music Mashups of 2014

Rito Pls Buff: The 10 Least Played Champions in LoL Season 4

10 Covers of Popular Songs that are Better than the Originals

Must See TV: The 9 Most Anticipated Shows of 2015

The 15 Biggest Box Office Bombs of All Time

10 Things The World Can’t Stand About Americans

Picture Perfect: The 6 Smartphones with the Best Cameras

The 10 Best Countries To Work In the World

A Profitable Day At The Track: 5 Tips For Betting On Horses

Tearing You Apart: 6 Bad Habits That Ruin Relationships

Learning on the Job: The 6 Biggest Mistakes Parents Make

Shopaholics Rejoice: The 12 Biggest Malls in the World

Fright Night: 10 Horror Movies Based on True Stories

Mach Mania: The 10 Fastest Jets in the World

Military Heavyweights: The 10 Countries with the Most Tanks

All In: The 7 Richest Poker Players in the World

Abracadabra: The 10 Best Magicians in the World

The 10 Richest Asian Countries in the World in 2014

Eyes in the Sky: 10 Things You Need to Know About Drones

Rising Stars: The 6 Best Silicon Valley Startups

Military Muscle: The 5 Most Advanced Armies in South America

All that Glitters: The 7 Most Luxurious Jewelry Brands in the World

5 Things You Didn’t Know About ISIS but Should

Empowering Your Money: The 5 Best Energy Stocks to Invest In

The 11 Best Android Apps You Can’t Get on iOS

The 10 Most Important International Conflicts in 2014

Mood Enhancers: The 20 Most Uplifting Songs of all Time

Lover Beware: The 8 Countries that Cheat the Most

Breath of Fresh Air: The 25 Countries with the Best Air Quality on the Planet

Singles Beware: The 8 Worst Mistakes Made on First Dates

Healthy and Happy: The 10 Countries with Lowest Healthcare Costs

The 6 Best Company Team Building Activities to Build Workplace Camaraderie

Ships Ahoy: The 10 Busiest Shipping Ports in the World

10 Productivity Tips to Save You Time and Help You Do More With Less

Grab a Bite: The Most Popular Fast Food Restaurants in America

Friday Night Thirst: The 10 Most Popular Cocktails in the World

The 6 Greatest Unsolved Mysteries We May Never Figure Out

7 Useless Products You Never Should’ve Bought

The 5 Reasons Why You’re Single and Miserable

The 7 Most Addictive Foods in the World We Can’t Stop Eating (Even Though We Should)

5 Amazing Places You Can Swim with Dolphins

The Top 7 Most Livable Countries In The World

The 10 Most Expensive Baseball Cards Ever Pulled From A Pack

The 5 Easiest Second Languages to Learn for English Speakers

Silver Spoon: The 6 Richest Families in the World

The 20 Countries with the Largest Prison Populations in the World

The Top 10 Richest Actors in the World

The 10 Best Airline Stocks to Invest In Before They Fly Too High

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!