US regulators are contemplating tighter capital requirements for the big banks, which could force them to withhold dividend payments.
Several news sources recently reported the Federal Reserve and the FDIC are weighing tough capital requirements for the nation’s money center banks. The new standards may even force the banks to withhold dividend payments for as long as five years. And this is something else for investors in financials to seriously consider.
A Brief Primer on Proposed Capital Requirements
The new standard would increase the amount of required capital to 6% of combined assets – regardless of the risk. According to Bloomberg News this is twice the level established by the Basel III Accord which was set at 3%, a leverage ratio US lawmakers have been pressuring regulators to beyond.
While tighter leverage ratios are a necessary safety measure to prevent bank failures, one has to wonder whether the new proposed standard could hand cuff the banks from raising capital by selling shares. If the report is accurate about how banks would be forced to halt dividend payments for five years, then an onerous 6% standard could have unintended consequences.
How Will Proposed Standards Affect the Banks?
Some observers argue such a tight threshold means the banks will need to retain more of their earnings. So withholding dividend payments will allow banks to build capital. Without getting lost in the weeds of counting assets and calculating simple leverage, it seems investors will be forced to put their money elsewhere.
Moreover, the banks will also be forced to rein in lending in order to comply with the proposed standard. And the liquidity needed in the consumer finance and housing markets will be harder to find. Ultimately the long overdue housing recovery and a return to economic growth and job creation may be hampered – a lingering problem since the financial tsunami of 2008.
Which US Banks Are at Risk?
Some of the nation’s big banks like Bank of America Corp (NYSE:BAC), Citigroup Inc (NYSE:C), and JPMorgan Chase & Co. (NYSE:JPM) would be caught up in the 6% dragnet, according to estimates by one investment bank cited in the Bloomberg story.
Tighter capital requirements obviously will ensure better stability for the financial system. At the same time, some analysts argue tightening the threshold in “volatile” markets could drain the system of much needed capital from investors. And this only adds to the legal and regulatory challenges these and other large lenders are facing.
Preexisting Regulatory Challenges
Let’s start with Bank of America Corp (NYSE:BAC). Many of the bank’s current regulatory and legal woes stem from the acquisition of Countrywide Mortgage and all its contingent liabilities. For instance, the Consumer Finance Protection Bureau (CFPB) recently announced that Bank of America Corp (NYSE:BAC) handles customer service complaints on nearly 15% of U.S. home loans. This apparently accounts for about 30% of all the mortgage complaints the CFPB has logged this year – and the issues are directly tied to the ill fated acquisition of Countrywide.
Meanwhile Citigroup Inc (NYSE:C) agreed to pony up $730 million earlier this year to settle allegations with the overseer of Fannie and Freddie – the Federal Housing Finance Authority (FHFA). In this caper the too-big-to-fail bank was slapped for deceiving investors in securities backed by mortgage loans, and the bank’s profit took a $1.3 billion hit to cover the total legal costs.
And let’s not forget JPMorgan Chase & Co. (NYSE:JPM)’s London Whale blunder where the bank took wrong bets on so-called synthetic credit swaps and got harpooned with a loss of more than $5 billion. While the figure is only a drop in the huge ocean of the big bank’s coffers, regulators and Congressional lawmakers took JPMorgan Chase & Co. (NYSE:JPM) to task for this busted deal.
There are other tricky days waiting around the corner for these large lenders. One high hurdle is the LIBOR rate rigging probe which will surely rear its ugly head again soon. And there is breaking news from across the pond. The European Commission is bringing an anti-trust case charging 13 of the world’s big banks, including the big players mentioned here, with blocking smaller financial outfits from entering the credit default swap market.
The Bottom Line
Combining all this fun news with the still evolving story about proposed new leverage standards means more uncertainty. And this is never a good thing for investors. Whether or not the onerous 6% capital requirement will be implemented remains to be seen. But the prospect of halting dividend payments is but another yellow flag. In the meantime, investors looking to buy into financials should consider other alternatives like smaller community banks that offer better buying opportunities.
The article New Leverage Standard Could Stifle Bank Dividends originally appeared on Fool.com.
Kyle Colona has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America, Citigroup Inc (NYSE:C), and JPMorgan Chase & Co (NYSE:JPM). Kyle is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
