Even Wells Fargo Challenged by Brown-Vitter

NEW YORK ( TheStreet) -- Wells Fargo ( WFC) would have the highest capital ratio among the largest U.S. banks under the Brown-Vitter bill, but would still need to raise a huge amount of capital or take other radical measures to comply, according to KBW analyst Frederick Cannon.

Senators Sherrod Brown (D., Ohio) and David Vitter (R., La.) last Wednesday introduced the Terminating Bailouts for Taxpayer Fairness Act, which would require "megabanks" with total assets of over $500 billion to raise capital levels to at least 15% of total assets.

The TBTF Bill -- which also conveniently stands for "too big to fail" -- raises capital requirements for the largest banks while also requiring regulators to "walk away from Basel III," by throwing out risk-based asset calculations for use in capital ratios.

Under the Basel III agreement, which 27 countries have signed, including the U.S., all key members of the European Union, Russia, China, India and Brazil, banks' minimum capital requirements are based on a Tier 1 common equity ratio, with risk-weighted assets in the denominator. This means that banks' capital requirements are based in part on the perceived risk of their assets. For example, cash has a zero risk-weighting, so it is not added to risk-weighted assets and it doesn't increase a bank's capital requirement. Direct obligations of the U.S. government have a 20% risk-weighting. Mortgage-backed securities with AAA or AA ratings have a 20% rating. A-rated MBS have a 50% risk-weighting, while BBB paper has a 100% risk-weighting and BB paper has a 200% risk-weighting under Basel III, because of the higher likelihood of default.

In addition to a minimum Tier 1 common equity ratio requirement of 7.0%, Basel III also requires capital buffers for global systemically important financial institutions, or GSIFIs. Based on determinations by the Basel Committee, the additional capital surcharges for Citigroup ( C) and JPMorgan Chase ( JPM) are 2.5%, so each of these banks has a fully phased-in minimum Basel III Tier 1 common equity ratio requirement of 9.5%.

For Bank of America ( BAC) and Wells Fargo ( WFC), the surcharge is 1%, for fully phased in Basel III Tier 1 common equity ratio requirements of 8.0% for each company.

For Goldman Sachs and Morgan Stanley, the surcharge is 1.5%, for a fully phased in Basel III Tier 1 common equity ratio requirements of 8.5% for each investment bank.

The Federal Reserve has yet to finalize its enhanced capital rules, as required under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, but the proposed capital rules pretty much fall in line with Basel III.

Under the Brown-Vitter bill, the minimum capital requirement for the large banks is Tier 1 common equity of 15% of total assets, with no risk-weighting at all. This means that cash would be considered just as risky as junk bond investments.

But 15% of total assets -- with adjustments for uncollateralized derivatives -- is a huge amount of capital.

At the end of the first quarter, JPMorgan Chase and Citigroup were close to being in compliance with the Basel III requirement, years ahead of the full implementation in January 2019, reporting respective estimated Basel III Tier 1 common equity ratios of 8.90% and 9.30%.

Bank of America and Wells Fargo were already in full compliance, reporting respective estimated Basel III Tier 1 common equity ratios of 9.42% and 8.39%.

Goldman Sachs was already in full compliance, with a March 31 Basel III Tier 1 common equity ratio of 9.00%. Morgan Stanley was even further ahead, with a March 31 Basel III Tier 1 common equity ratio of 9.80%.

While Cannon sees "little chance" of the Brown-Vitter bill passing, he wrote that "its proposals for higher and simpler capital requirements for the largest banks echo recent comments from officials from the FDIC and the Federal Reserve."

"While all six of these banks have made meaningful progress on Basel III capital ratios, there is wide variation their levels on the other measures," Cannon wrote.

First the Good News

When comparing ratios of tangible common equity to total assets, as currently calculated, it is quite clear the biggest U.S. banks have significantly boosted their capital strength over the past five years, according to KBW's calculations:
  • JPMorgan's ratio of tangible common equity to total assets was 6.36% as of March 31, increasing from 5.06% at the end of 2007
  • Citigroup's ratio of tangible common equity to total assets increased to 8.87% from 3.35% over the same period
  • Bank of America's ratio of tangible common equity to total assets increased to 7.09% from 3.89%
  • Wells Fargo's ratio of tangible common equity to total assets grew to 8.53% from 6.09%.
  • For Goldman Sachs, the ratio of tangible common equity to total assets increased to 7.07% from 3.26%
  • Morgan Stanley's ratio of tangible common equity to total assets increased to 6.85% from 2.60%

Brown-Vitter Fear

KBW also estimated what the big bank's regulatory ratios of Tier 1 common equity to total assets would be as March 31, if Congress decided to throw away years of its own work on Dodd-Frank, as well as U.S. bank regulators' multiyear negotiations with the Basel committee on the Basel III framework. Under Brown-Vitter bill, the current ratios would be much lower, because of the adjustments for uncollateralized derivatives:
  • Under the proposal by Senators Brown and Vitter, JPMorgan's ratio of tangible common equity to total assets would be 4.16%
  • Citigroup's ratio of tangible common equity to total assets would be 6.12%
  • For Bank of America, the ratio of tangible common equity to total assets would be 4.71%
  • Wells Fargo's ratio of tangible common equity to total assets would be the highest among the six largest U.S. banks, at 8.27%
  • For Goldman, the ratio of tangible common equity to total assets would be 4.70%
  • Morgan Stanley's ratio of tangible common equity to total assets would be 3.93%

So there you have it. By KBW's calculations, even Wells Fargo would be woefully short of capital under the Brown-Vitter bill, underscoring the bill's radical nature, years into the implementation of Dodd-Frank.

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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