Quick Thoughts – BAC: A Capital Tsunami

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SEE LAST PAGE OF THIS REPORT Howard Mason

FOR IMPORTANT DISCLOSURES 203.901.1635

hmason@ssrllc.com

November 7, 2013

Quick Thoughts – BAC: A Capital Tsunami

Since the Fed released guidelines for the
2014 CCAR
process on November 1st, investors have expressed concern that the stress tests have been stiffened and that more capital than previously expected will be trapped in the banks in general and BAC in particular; more headlines around litigation, and BAC’s increase in its estimate of potential legal costs beyond reserves to $5.1bn in Q3 from $2.8bn in Q2, have not helped.

While the stress tests have been refined, and now include for example a more specific test related to counterparty risk, we think the impact will be more to shape how banks manage internal risk processes and outcomes than to lead to meaningfully higher enterprise capital requirements.

Brian Moynihan at BAC articulated this
view
yesterday on CNBC: “we just got the new stress test … and I can understand why people outside the industry would look at it and say this is just another thing coming at you. But if you start with the right amount of capital and you built the risk right generally you’re in pretty good shape on most of these rules.

As an example, BAC now has an equity/assets ratio of 11% versus below 9% in 2007 and a risk-based “tier-1 common” capital ratio of 9.9% (on a fully-loaded Basel 3 basis) versus the minimum regulatory requirement of 8.5% (a baseline of 7% plus a 1.5% buffer as a “bucket 2” bank); on $1.33 trillion of risk-weighted assets, the difference represents $18bn of excess regulatory capital. Even under the hypothetical “severely adverse” scenario of the
mid-cycle stress test
, the ratio was 9.2% representing excess capital of $8bn.

Furthermore, we estimate BAC will generate excess capital of $25bn over the next two years. In short, even under stress, BAC has or will generate excess capital of more than $30bn by end 2015; to give a sense of scale, we note that if all this were deployed in a hypothetical buy-back of stock at the current price (so no increase in either dividend or stock price and no legal expenses above reserves), BAC would retire over 2 billion shares or nearly one-fifth or present shares outstanding of 11.4bn on a fully-diluted basis.

If BAC’s legal expenses are indeed $5 billion above reserves, it reduces the potential stock buyback in the hypothetical scenario by ~250 million shares.

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