U.S. Banks: 3Q23 Regulatory Capital & TLAC Review

FINANCIAL METRICS

Banks and investors are in regulatory limbo as we await the end of various comment periods after the Fed dropped a long list of proposed reforms ranging from Long-term Debt (LTD) requirements for Category III-IV banks to sweeping Basel III endgame changes to the risk-weighting framework to tweaking certain GSIB methodologies (Method 2 surcharge and TLAC qualification).

We continue to view the Basel III reforms as having the most uncertain timeline and greatest capacity for changes in the ultimate rule writing—underscored by the Fed extending the already-long 120 day comment period (now ending January 2024), and the fact that two out of six members voted against the proposal. Contrast that to the unanimous regional bank LTD proposal, where pushback from Bowman and Waller centered around appropriate tailoring of requirements by bank risk and complexity, rather than the underlying concepts. And while the regulatory proposal has met with the predictable industry backlash, there were notably bipartisan concerns raised during Barr’s Congressional testimony in early November—main talking points being procedural rigor and data reliance in crafting the rules, and (relatedly) the cost/benefit analysis for end credit consumers.

Timing is also an issue when it comes to finalizing Basel III however: given the U.S.’ delinquency in crafting the proposals and general need to align timelines with other regions, regulators would need to move fast to meet the 2025 target for starting implementation. That’s particularly relevant for Market RWAs and the CVA adjustment, where U.S. banks more typically compete heads-up with foreign institutions and where staggered regulatory phase-in schedules could disrupt the competitive playing field. Although not our base case, we wonder if the Fed could look to separate out certain segments of the 1000+ page proposal and stagger finalization to maintain consistent chronology across global regimes.

Running Through the Ratios

3Q23 Capital Snapshots

During 3Q23, most Category I and II banks saw their capital ratios increase compared to 2Q23; buybacks remain fairly subdued with sector payout ratios sitting around 60% as banks build nominal capital in preparation for higher RWAs due to Basel III. Nominal share repurchases during the quarter were just ~25% of the pre-pandemic 3Q19 level. That said, we could easily see buybacks tick higher in 2024 after meaningful CET1 accretion this year, especially as equity multiples remain depressed and seemingly offer an attractive return to management teams.

The biggest sequential increase in the peer group was JPMorgan reporting a 47 bp increase in its CET1 ratio, increasing resulting in a 289 bp cushion over requirements when incorporating the new SCBs that went into effect at the beginning of 4Q23. The sequential increase reflects the firm’s RWA optimization actions and strong earnings generation, partially offset by share repurchases and common dividend payouts. Bank of America had the second largest sequential CET1 ratio increase in the peer group, with the firm’s CET1 ratio increasing 30 bp to 11.9% reflecting a 240 bp cushion over its CET1 requirement effective as of 4Q23. Similar to JPM, BAC’s sequential CET1 ratio increase primarily reflects the firm’s ongoing RWA optimization actions and strong earnings generation, partially offset by share repurchases and common dividend payouts.