Following the banking crisis, the market is looking at banks' balance sheets very differently than it used to in order to ensure banks are well positioned in case another curve ball comes their way.
One thing investors are looking at differently are bank capital levels, particularly among the super-regional banks, which don't have to incorporate unrealized bond losses into their regulatory capital ratios. Investors want to make sure banks have adequate capital not only if things go wrong but also because regulators look poised to increase regulatory capital requirements for this group of bank stocks.
Let's look at which super-regional bank is in the best capital position, according to reported numbers at the end of the first quarter.
Incorporating unrealized losses
One factor that contributed to the bank failures that occurred earlier this year is that banks loaded up on longer-term, low-yielding bonds too early in the cycle.
As interest rates soared between March 2022 and now, these bonds got crushed because bond values and bond yields have an inverse relationship. Then, as deposits started to flow out of the system, investors got worried that banks would have to sell bonds while they traded at a loss to cover deposit outflows, which would destroy shareholder equity. This dynamic is one of the main culprits that led to deposit runs at most of the banks that failed recently.
Super-regional banks with assets between $150 billion and $700 billion are also bracing for more-stringent regulatory capital requirements that could force them to incorporate unrealized bond losses in their available-for-sale (AFS) bond portfolios into their common equity tier 1 (CET1) capital ratios.
The CET1 ratios are a key capital ratio at banks that look at their core capital expressed as a percentage of their risk-weighted assets such as loans. AFS bonds are those a bank intends to sell prior to maturity. Currently, these unrealized losses and gains are not incorporated into the CET1 ratios of super-regional banks. Investors are now looking at what these bank CET1 ratios would look like with the AFS unrealized losses added in. These losses can be seen through a line item called accumulated other comprehensive income (AOCI).
The chart below looks at bank CET1 ratios at the end of the first quarter taking AOCI into account as well as their regulatory capital requirements to show what their excess capital position would have looked like at the end of the first quarter.
| Bank | Adjusted CET1 | CET1 Requirement | Excess Capital |
|---|---|---|---|
| U.S. Bancorp (USB -0.20%) | 6.4% | 7% | (0.6%) |
| PNC Financial (PNC 0.43%) | 7.5% | 7.4% | 0.1% |
| Truist Financial (TFC 0.14%) | 6.2% | 7% | (0.8%) |
| Citizens Financial Group (CFG -0.36%) | 8.7% | 7.9% | 0.8% |
| M&T Bank (MTB 0.19%) | 9.9%* | 9.2% | 0.7%* |
| Huntington Bancshares (HBAN 0.23%) | 7.61% | 7.8% | (0.19%) |
| Fifth Third Bancorp (FITB 0.35%) | 6.75% | 7% | (0.25%) |
| KeyCorp (KEY -0.35%) | 5.7% | 7% | (1.3%) |
| Regions Financial (RF 0.74%) | 7.6% | 7% | 0.6% |
Source: Bank earnings materials. Adjusted CET1 includes provisions for accumulated other comprehensive income. *= Q4 2022 numbers
As you can see, if AOCI were incorporated into bank CET1 ratios at the end of the first quarter, more than half of these banks would see their capital ratios fall under their current regulatory requirements. KeyCorp would see the biggest deficit with its adjusted CET1 ratio below its requirement by 1.3 percentage points. This likely at least partly explains why the stock is down more than 42% this year, which is more than the broader banking sector.
On an adjusted basis, Citizens Financial would have the best capital position with 0.80%, or 80 basis points of excess capital above its regulatory requirement. M&T Bank would likely be next, although I had to use fourth-quarter 2022 numbers because I couldn't find the proper inputs in M&T's first-quarter earnings material or regulatory filing. Regions is also in good position at 60 basis points of adjusted excess capital.
These are the banks that didn't get too deeply invested in bonds too early in the cycle.
Keep this in mind
I definitely think this group of banks is going to see higher capital requirements from the regulators, which could be announced soon. But these usually take time to implement, providing these banks with time to build capital and also grind down their unrealized losses. Therefore many of these banks should be able to adapt.
But with the uncertainty right now, many of these banks don't look to be in a great position to return capital to shareholders anytime soon. Even Citizens, M&T, and Regions are likely going to be on pause or be doing limited share repurchases until there is further clarity.
This is likely one of the factors keeping bank stocks depressed. Investors will need more clarity on regulatory capital and capital return plans before they can get really comfortable with bank capital positions again.
