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Shareholders of Bank of America (BAC 0.23%) could be in for a windfall if the incoming presidential administration follows through on its promise to roll-back the 2010 Dodd-Frank Act.
There are a number of ways this would help Bank of America, but one of the most important involves eliminating the Federal Reserve's veto power over bank capital plans -- i.e., dividend and stock repurchase plans.
Overflowing with excess capital
I've discussed this previously, but it wasn't until recently that I sat down to figure out more precisely how much this could benefit Bank of America's shareholders.
Let me walk you through the math.
To be considered well-capitalized for regulatory purposes, Bank of America must hold roughly $91 billion worth of tier 1 common capital -- unencumbered tangible common shareholders' equity. That translates to a 5.875% common equity tier 1 capital ratio.
If you look at its balance sheet, however, it holds $170 billion worth of tier 1 common capital, which equates to an 11% common equity tier 1 capital ratio.
This means that Bank of America has approximately $80 billion worth of excess capital on its balance sheet, almost twice the amount it needs in order to be considered well-capitalized.
All figures refer to common equity tier 1 capital. Data source: Bank of America's 3Q16 10-Q, page 41. Chart by author.
Benefits and minuses to excess capital
This isn't necessarily a bad problem to have. The more unencumbered capital Bank of America has on its balance sheet, holding all else equal, the safer it is. At the same time, however, as I discussed at greater length here, all that excess capital drives down the perception of Bank of America's profitability.
As with all bank stocks, analysts and investors use Bank of America's return on equity to gauge how profitable it is. And because shareholders' equity -- i.e., capital -- is in the denominator of the return-on-equity calculation, higher capital leads to lower profitability.
This goes a long way toward explaining why, eight years after the financial crisis, Bank of America is still coming up meaningfully short of its profitability targets. While it's striving for a 12% return on tangible common equity, the figure for the third quarter was only 10.3%,
It's for this reason that Bank of America CEO Brian Moynihan intimated at an industry conference earlier this month that eliminating the Fed's veto power over bank capital plans is at the top of his wish list for a rollback in bank regulations:
For us as a company, just because of where we are, it's about capital return. At the end of the day, we're overcapitalized. We can fund all the activity that customers need within the balance sheet. So if we return capital, that capital goes out in the industry and ends up somewhere else. So to me, it's certainly around the ability to have access to your capital return once you've met all the hurdles. And whether those hurdles move up or down because of various peoples' points of view, the issue is the industry's above them, and now we need to be able to get the capital out.
According to his math, after everything else is taken into consideration, this could translate into a return of around $15 billion to shareholders in one fell swoop. That's enough for Bank of America to double both its dividend and its current rate of stock buybacks.
