The Prudential Regulation Authority (PRA)’s Pillar 2A and 2B buffers for UK banks will generate a far more nuanced and idiosyncratic set of end-state capital ratios, believes Jefferies.
Joseph Dickerson and team at Jefferies in their recent report on UK banks point out that the Prudential Regulation Authority’s August consultation paper on implementation of EU capital requirements known as CRD IV has driven substantial controversy around the end-state capital ratios of UK banks.
Pillar 2 provisions for UK banks
In August, PRA came out with a consultation paper titled “Strengthening capital standards: implementing CRD IV”.
Jefferies analysts point out that the proposed changes around Pillar 2 provisions are a major focus of the recent consultation paper and are subject to various forms of interpretations. The analysts opine the document contains two key proposals viz.: Pillar 2A capital requirement to be met with at least 56% common equity Tier 1 (CET1) from January 2015 and Pillar 2B buffers are required if CDRIV buffers are insufficient.
Jefferies analysts point out that some wrongly conclude UK banks will all need to meet a fully-loaded CET1 ratio of 13% before distributing material quantum earnings. Their conclusion was reinforced when RBS announced on 1st November that it was targeting a fully loaded Basel 3 CT1 ratio of 12% or beyond by the end of 2016.
No risk to Barclays’ dividend pay-out target
Based on the research done by Jefferies analysts on the factors that define UK bank’s Pillar 2A and 2B buffers, the analysts conclude that the exercise will generate a far more nuanced and idiosyncratic set of end-state capital ratios.
Jefferies analysts also conclude that Barclays’ 10.5% CET1 target looks tenable under the analysts’ interpretation of the PRA’s rule and that Lloyds Banking Group PLC (ADR) (NYSE:LYG) (LON:LLOY)’s go-to CET1 level may be 200-300 bps higher than investors anticipate.
In summation, Jefferies analysts believe there is no risk to Barclays PLC (ADR) (NYSE:BCS) (LON:BARC)’ dividend pay-out target of 40 to 50% of earnings in 2014.
However, the analysts point out that Lloyds Banking Group PLC (ADR) (NYSE:LYG) (LON:LLOY) could be potentially exposed depending on treatment of ring-fence buffers.
As regards Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) (AMS:RBS) is concerned, the analysts believe that the increase in RBS’ go-to capital ratio was driven by increased stress loss buffers largely due to commercial real estate and sub B+ credits in the banking book. Jefferies analysts thus believe that Barclays PLC (ADR) (NYSE:BCS) (LON:BARC)’ CET1 ratio will end up being lower than 13% after the sell down of its Capital Resolution unit is largely complete.
The following table depicts Jefferies analysts’ overall estimates of the three UK banks:
