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Earlier this week, financial regulators rolled out a stream of harsh leverage ratios for the largest financial institutions across the country.

The move could force some of the nation's largest banks to have to raise equity capital, sell assets, suspend dividend hikes, or postpone share buybacks in order to grow retained earnings and boost capital.

Levers to Pull

Banks have several levers to pull in order to lower leverage ratios to meet capital standards. Recall, leverage standards are usually some form of debt-to-equity or debt-to-assets ratio and thus there are a few levers that can be pulled to boost these ratios to meet new standards.

To lower risk-weighted-assets, a measure of the bank's riskiness of its book, banks could sell some riskier assets and hold more cash. This is very negative as it would lead to slower lending growth, which is directly tied to economic growth. Thus, regulators have decided to become more concerned with debt-to-equity ratios.

The four main levers that banks can pull to fight higher capital ratios include:


  • Sell risky assets.
  • Raise equity capital (sell more stock and dilute existing shareholders).
  • Boost retained earnings by halting dividend hikes or shrinking dividends.
  • Halting stock buybacks to boost retained earnings.

Stricter Regulations

Earlier this week, the FDIC, the Office of the Comptroller of the Currency, and the Federal Reserve proposed new capital standards that could force the nation's largest banks to double capital held against most assets and force them to raise massive amounts of capital or shrink their balance sheets. Eight firms identified by the regulators need to raise leverage ratios to 5 percent, above the 3 percent agreed upon in the Basel III agreement. Meanwhile, those of the eight with FDIC insured subsidiaries must meet a 6 percent ratio as a tax on any future bailout loan from the FDIC.

Analysts at Keefe, Bruyette and Woods weighed in after the news identifying capital shortfalls at some of the country's largest banks. They noted four large banks that need lots of capital:


  • J.P. Morgan Chase and Co. (NYSE: JPM) needs $15.6 billion in capital, or 7.5 percent of market cap.
  • Morgan Stanley (NYSE: MS) needs $14.1 billion in capital, or 28.14 percent of market cap.
  • Citigroup (NYSE: C) needs $13.2 billion in capital, or 8.65 percent of market cap.
  • Goldman Sachs (NYSE: GS) needs $4.9 billion in capital, or 6.8 of market cap.
  • Wells Fargo (NYSE: WFC) and Bank of America (NYSE: BAC) have enough capital to meet the 5 percent threshold.

Earnings In Focus

Friday, J.P. Morgan Chase and Wells Fargo report second quarter earnings and eyes will be on these reports especially in relation to the new capital standards but also to the rise in interest rates. Comments on both regulatory standards and net interest margins, correlated to lending profits, will be closely watched in these releases.

Posted-In: Analyst Color Earnings News Previews Federal Reserve Hot After-Hours Center Markets Best of Benzinga

 

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