Regionals Anticipate Smooth Transition to Basel III

Unlike their money-center counterparts, the nation's big regional banking companies, with their relatively prosaic balance sheets, are not set for a dramatic metamorphosis under the pending Basel III risk weightings.

With most having finished the third quarter above the new regulatory framework's universal Tier 1 common equity ratio target of 7%, many have expressed comfort about the coming transition. Nevertheless, capital issues are still pressing: Among them, federal bailout investments remain outstanding, and reductions in asset portfolios have been important in controlling leverage at some institutions in the sector (see charts below), raising doubts about their fundamental profitability.

Moreover, it is unclear whether the regionals' risk adjustments will be untouched. In a report this month, analysts at KBW Inc.'s Keefe, Bruyette & Woods Inc. wrote that they expect the Basel rules ultimately to amplify heavier weightings for capital markets assets — which would fall hard on Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. — with tougher formulas for other assets "that contributed to the financial crisis," such as mortgages and construction loans, thus plumping up equity ratio denominators across most of the industry.

Concerning the regionals' numerators, PNC Financial Services Group Inc. stands out for the possibility that much of its large stake in BlackRock Inc. would be deducted from regulatory capital to satisfy the limit on the share of minority investments in financial institutions. The company has reckoned that it could face a hit of roughly $4 billion at most (a figure based on its holding before it sold about one-fifth of its position in the asset manager last month), which would have put its Tier 1 common ratio at about 8% in the third quarter.

Under the Dodd-Frank Act, all the companies charted here would automatically be considered systemically important because of their size and, thus, are subject to stricter prudential standards. But specifics have not been determined, and the KBW analysts wrote that recent signals from regulators indicate that imposition of a meaningful capital surcharge is unlikely for such institutions.

They highlighted the Federal Reserve's focus on Basel III's universal 7% target in guidelines on dividend plans the central bank published last month and the Basel Committee on Banking Supervision's press release this month saying it would complete a study on an additional cushion for large entities by mid-2011. That "is a considerable watering down" of the language the Basel Committee used last month, according to the KBW analysts, and "suggests that agreement on a globally systemic buffer could be breaking down."

(In a presentation this month, James Rohr, PNC's chief executive, said that he expects additional requirements for large companies would be scaled according to their relative size and the risks they pose.)

U.S. Bancorp, one of the strongest companies to emerge from the crisis, is among those that have perceived a green light. It has said it might lift its dividend in the first quarter, and that earnings that could boost its capital ratio by 20 to 30 basis points every three months give it considerable latitude.

By contrast, KBW has put companies like SunTrust Banks Inc., Regions Financial Corp. and Fifth Third Bancorp — all of which still have preferred shares held by the Treasury Department — in a class marked by questionable earnings power and a longer prospective road out of capital purgatory.