BAC – Capital Restatement is a Bitter Pill, but Expect $15bn Stock Buyback in 2015

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SEE LAST PAGE OF THIS REPORT Howard Mason

FOR IMPORTANT DISCLOSURES 203.901.1635

hmason@ssrllc.com

April 28, 2014

Quick Thoughts:

BAC – Capital Restatement is a Bitter Pill, but Expect $15bn Stock Buyback in 2015

  • BAC is resubmitting its 2014 (“CCAR”) capital plan to the Fed after discovering an accounting error (related to structured notes acquired with Merrill in 2009) which reduces Tier 1 common capital at December 2013 by $3.7bn and the common-equity (“CET1”) portion of this at March 2014 by $720mm; in the meantime, management has suspended the $4bn buyback and dividend-lift from 1 cent to 5 cents per quarter which the Fed had approved for 2014.
  • While there is no impact on GAAP reporting and the 30bps decline in key regulatory capital and leverage ratios  leaves them well above the regulatory minimums (with the fully phased-in Basel 3 CET1 ratio falling to 9.0% under the standardized approach and 9.6% under the advanced approach), there is a significant issue with the projections under the CCAR in the “severely adverse” scenario.
  • BAC had to resubmit its original capital plan (lowering the planned return of capital to shareholders) because, under this stress scenario, its Tier 1 common ratio would have fallen to the regulatory minimum of 5.0% and Tier 1 leverage ratio to 3.9% (versus the regulatory minimum of 4%); under the revised plan which was approved, these stressed ratios were 5.3% and 4.1% respectively.
  • In other words, the Fed demanded a buffer over regulatory minimums. This buffer has been eliminated by the restatement of Tier 1 common capital and the Fed’s estimate of the BAC’s regulatory capital requirement for operating risk will likely have increased over that in the CCAR approval because of the restatement (and, possibly, because of reports of a mortgage-related settlement with the Department of Justice).
  • As a result, BAC will need to substantially reduce planned capital returns. Given the CEO has prioritized share buyback, we do not expect the dividend increase to stand and we expect the buyback to cut from $4bn to $2bn. It is a bitter pill for shareholders to swallow.
  • Nonetheless, we see this as a 2014 issue and expect BAC to increase its buyback to $15bn (representing a 90% payout ratio) in 2015 as the tangible ROE improves to 13% with the operating jaws of rising net interest margin (to 3.4% in 2015 from the 3.0% in 2013) and declining core expenses ($51.6bn in 2015 vs. $53.3bn in 2013).

Further details of the capital generation at BAC, and our model, are set out in a note of January 20th titled “
BAC: Room to Run as Rising Net Interest Margin Levers over Declining Expenses
”.

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