Banks Should Do Own Operation Twist: Analyst - TheStreet

NEW YORK (

TheStreet

) -- Large banks should do an "operation twist" of their own, Stifel Nicolaus analysts argued in a report on Thursday, selling low yielding assets and using the proceeds to delever their balance sheet.

That would boost capital, which could then be redeployed in businesses that have a higher return or can be used to make buybacks that shareholders will welcome.

Bank stocks were deep in the red Thursday after the

Federal Reserve

pointed to "significant downside risks" to the economy as a justification for its third stimulus since the recession.

The central bank said Wednesday that it will sell short-term securities and buy $400 billion in longer-dated Treasurys, in an attempt to further lower long-term interest rates. The move, called operation twist, is expected to create additional pressure on spreads for banks.

Bank of America

(BAC) - Get Report

,

JPMorgan Chase

(JPM) - Get Report

,

Citigroup

(C) - Get Report

and

Wells Fargo

(WFC) - Get Report

were down between 3 % and 5% on Thursday.

Goldman Sachs

(GS) - Get Report

and

Morgan Stanley

(MS) - Get Report

were shedding 4.4% and 6.6% respectively.

But Stifel analysts Christopher Mutascio and Charles Nabhan analysts think banks should "cry uncle" when it comes to maintaining their large balance sheets. "With the Fed determined to flatten the yield curve like a pancake, why should the banks carry large balance sheets that maintain low spread asset/liabilities wrote in a report?" they wrote. "Why not massively delever the balance sheets by selling low yielding earnings assets and paying down a like amount of liabilities? This would increase capital ratios and allow managements to re-allocate capital to higher ROE business segments and/or buy back a material amount of shares outstanding (at price below tangible book value in many cases)."

While selling assets would depress earnings per share in the near term, it would be offset by the positive impact from potential buybacks as a result of the de-leveraging process. Plus, investors weren't willing to pay much for a low-spread business anyway. Instead, they would probably applaud de-leveraging by banks, if it leads to a better use of capital.

The analysts calculate that if JPMorgan were to sell $400 billion in assets and pay down liabilities of the same amount, it could cost it 86 cents per share in earnings before buybacks. However, it would boost its tangible common equity ratio from 5.7% to 7%. If half of that extra capital is used to buy back shares, it would reduce the earnings impact to 39 cents from the original hit of 86 cents.

"Of course it will take time to buy back such a significant amount of shares and the regulators could potentially stand in their way in the near-term," the analysts acknowledged. "But, having an arsenal of excess capital that eventually will have to be redeployed should warrant a higher valuation than investors are currently willing to provide the bank, in our opinion, especially if it comes at the expense of low spread, low ROE asset/liability spreads."

--Written by Shanthi Bharatwaj in New York

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