Citigroup Inc (NYSE:C) and Bank of America Corp (NYSE:BAC) should have the greatest amount of excess capital as a percentage of market caps over the next couple of years, points out Bernstein in its recent research report.
John E. McDonald and the team at Bernstein Research in their recent research report proposed valuation based on excess capital the large-cap banks would build through 2015.
Banks have been in ‘capital build’ mode
Bernstein analysts point out that thanks to regulatory requirements towards minimum thresholds through Basel III and CCAR, banks have been in ‘capital build’ mode for the last several years. Furthermore, investors have been increasingly comfortable returning to traditional P/E-based valuations for the bank stocks.
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The analysts, however, point out that with banks now having their 2018 regulatory minimums largely in-sight, hopefully they will be shifting to a clearer capital distribution mode. Hence the analysts believe it may be time to broaden our notions of valuation, by incorporating both earnings power and excess capital.
Banks with excess capital
Bernstein analysts define excess capital as a bank’s Basel III Tier 1 Common capital in 2015, inclusive of modeled distributions, in excess of the total of each banks’ estimated minimum capital levels.
This signifies the aggregate of the industry wide 7% minimum, plus each bank’s specific SIFI buffer and in an incremental voluntary buffer. The analysts anticipate banks to maintain the incremental voluntary buffer to weather shifts in OCI and give them some flexibility to accommodate balance sheet growth or loan portfolio acquisitions. The following graph highlights estimated excess capital for each of the large banks in 2015 as a percentage of market cap.
Based on the analysis done by Bernstein, Citigroup Inc (NYSE:C) and Bank of America Corp (NYSE:BAC) should have the most excess capital to put to work in 2015. However, JPMorgan Chase & Co. (NYSE:JPM), U.S. Bancorp (NYSE:USB) and Wells Fargo & Co (NYSE:WFC) show more limited excess capital beyond the analysts’ modeled capital distribution, since they are already ramped up to average distributions as compared to Citigroup and Bank of America.
Large-cap banks above their estimated Basel III minimum Tier 1 common ratios
Bernstein analysts point out that with the exception of JPMorgan Chase & Co. (NYSE:JPM), all of the large-cap banks are currently already above their estimated Basel III minimum Tier 1 common ratios as of the third quarter of 2013. The following graph highlights the position:
The following table highlights the target prices as estimated by Bernstein for various large cap banks. The analysts point out that their target prices are based on an absolute P/E multiple on 2015 earnings estimates plus an add-on for their estimate of excess capital in 2015 discounted by a rough timeline for distribution of that excess capital:
According to John E. McDonald and the team at Bernstein Research, over the next 1 to 2 years, they believe large-cap banks will be transitioning from being capital builders to capital distributors.
The analysts conclude that within their coverage universe, they estimate Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) will be generating the most excess capital over the next few years. However based on current valuations, the analysts believe Citigroup offers the best risk/reward in the group.