Big Banks: Inflation Fear Losers

NEW YORK ( TheStreet) -- The nation's largest banks on Tuesday took a breather from their extended stock rally.

The broad indices all ended lower, after the Bureau of Labor Statistics reported the consumer price index rose by 0.5% in June, after rising just 0.1% during May. Economists polled by Thomson Reuters had expected the CPI to increase by just 0.3% in June.

This left investors even more certain that the Federal Reserve was ready to curtail its stimulus efforts as early as September, by lowering its monthly purchases of long-term securities from the current $85 billion.

The KBW Bank Index ( I:BKX) was down 1% to close at 64.33, with all but four of the 24 index components ending the session with declines. Shares of Zions Bancorporation ( ZION) were down 2.5%. Large banks showing 2% stock declines included Regions Financial ( RF) of Birmingham, Ala., SunTrust ( STI) of Atlanta, KeyCorp ( KEY) of Cleveland and Comerica ( CMA) of Dallas, which beat the consensus second-quarter earnings estimate, but also reported slowing loan growth.

'The Word of the Day Is "Comfortable".'

Goldman Sachs ( GS) reported second-quarter earnings of $1.9 billion, or $3.70 a share, soundly beating the consensus estimate of $2.89, according to Bloomberg.

The earnings beat was driven by $1.42 billion in revenue from its Investing & Lending unit, with rising marks on the company's private equity investments and its portfolio of equity and debt market securities. These key areas of Goldman's business are expected to be de-emphasized over coming years as the Volcker Rule and other new rules derived from the Dodd-Frank Wall Street Reform and Consumer Protection Act are finalized.

Another important question for investors and analysts is how the bank's efforts to comply with the Federal Reserve's final rules to implement Basel III, and federal regulators' new leverage capital requirements may affect the return of capital to shareholders.

After the Fed finalized its enhanced capital rules on July 2, the Fed, along with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. proposed a minimum Basel III supplementary Tier 1 leverage ratio of 6% for U.S. banks with total assets above $700 million, along with a 5% minimum ratio for the nation's largest bank holding companies, including Goldman. The new leverage ratio required is expected to be phased in starting in 2015, full compliance required by January 2018.

The minimum supplementary Tier 1 leverage ratio under Basel III is just 3%, meaning that large U.S. banks will operate at a serious disadvantage to foreign competitors, if the regulators have their way.

Following the completion of the Federal Reserve's annual stress tests for large banks in March, the regulator announced a "conditional" approval of Goldman's 2013 capital plan. The company didn't announce a dividend increase or new plans to buy back common shares, and was required to submit a revised capital plan to the Fed.

The company estimated that its Basel III Tier 1 common equity ratio under the Federal Reserve's final capital rules was 9.3% as of June 30. This puts it in compliance with the Tier 1 common ratio minimum of 8.5%, years ahead of the January 2019 deadline. However, Goldman didn't provide an estimate for its Basel III supplementary Tier 1 leverage ratio.

During the company's earnings conference call, Goldman CFO Harvey Schwartz gave the excuse that it was "hard to speculate" on how the final leverage ratio requirement will be finalized.

But that didn't stop three other large banks from doing just that, and providing investors with estimated Basel III supplementary Tier 1 leverage ratios as of June 30.

JPMorgan Chase ( JPM) estimated a 30 Basel III supplementary Tier 1 leverage ratio of 4.7% and predicted compliance with the latest capital rule by the first quarter of 2015, with compliance for its largest bank subsidiary "to follow."

Citigroup ( C) estimated its Basel III supplementary Tier 1 leverage was 4.9%.

Wells Fargo ( WFC) CEO John Stumpf said during his firm's earnings call on Friday that "based on our initial review of the leverage ratio proposal issued this week, we believe our current leverage levels would exceed the well-capitalized requirements at both the bank and the holding company."

Analysts took Goldman to task over its lack of disclosure, with Schwartz repeatedly saying the firm was "comfortable" with its initial assessment of the new leverage capital rules.

Morgan Stanley analyst Betsy Graseck asked "On the leverage ratio, when you say you're comfortable, what is your definition of comfortable?" Schwartz simply said "comfortable," after which he said "I'm not trying to be cute with you," after doing just that. He reiterated "Our early read is all of the things we've done on the balance sheet over the past several years have left us reasonably well positioned."

CLSA analyst Mike Mayo summed up the leverage capital discussion, during the call, by saying "I think the word of the day is 'comfortable'."

Before the call, KBW analyst Frederick Cannon wrote in a note to clients that "It is difficult to see how GS can optimize the return on capital given the little disclosure that is provided."

Cannon has a "market perform" rating on Goldman, with a price target of $155.00.

Goldman's shares were down 2% to close at $160.24.

GS Chart GS data by YCharts

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-- 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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