How the New “7% Rule” Could Affect Your Bank
Editor’s Note: This story replaces an earlier article we published about the new banking reserve requirements. The original article was based on inaccurate information, which led to mistaken conclusions about the effect of the new regulations on
Wall Street cheered the new bank rules announced this weekend — which is, I suppose, as good a reason to cheer as any.
The new rules govern how much capital needs to be behind a bank. Current rules say that common equity should equal 2% of total assets. The new regs call for 7%, or just more than three times as much as the current standard.
So if banks are going to be gob smacked by new capital requirements, why would Wall Street cheer?
Three reasons: An unknown became a known, which investors always like. Plus, the rules weren’t as bad as they could have been, and — this is the kicker — most banks already exceed this capital measure, and by a long .
The good news for investors is that they can rest easy: Bank executives won’t be scrambling to raise money from investors. The new requirements won’t hurt earnings by as much as a single penny.
So how does your bank fare?
Well, if you bank at one of the nation’s largest, the answer is likely “pretty good.”
Here’s a look at common equity rates at the nation’s largest banks:
J.P. Morgan Chase 8.3%
Bank of America 11.1%
Wells Fargo 11.5%
U.S. Bank 9.4%
PNC Bank 12.3%
HSBC Bank 9.3%
The Bank of New York Mellon 8.3%
SunTrust Bank 12.1%
Regions Bank 12.2%
That being said, about 450 banks in the country do not meet the new standard, though it’s not like they are up against a tight deadline to meet the new standard — they’ve got eight years, which should be more than enough time.
On the other hand, plenty of banks are running short on time by other measures. Bank failures are happening at the fastest pace in memory, with roughly 120 banks being shut down by regulators so far this year. And to make matters worse, another 829 financial institutions — more than one in 10 — are on FDIC chairman’s Sheila Barr’s “troubled banks” list.
While there’s no way to know if your bank is on the list — which is evidently the only secret in Washington that actually gets kept — there are metrics that show with a pretty good rate of accuracy which banks are in danger. I recently crunched the numbers on that score. [You can see my findings here]
The real reason Wall Street cheered, of course, is that the banks are going to be left alone to earn their way out of trouble. And that they likely will: Net interest margins are strong, banks are bringing in nearly $20 billion a quarter in fees alone, and for most of the big banks, the teetering-on-the-brink days of the financial crisis are over.
Since the market’s ebb, many banks have seen triple-digit returns. One hasn’t yet, though, and it might prove to be the last great investment in the class.
Action to Take –> If you’ve never considered Citigroup (NYSE: C), now might be the time. The bank, one of the nation’s largest, is strongly reserved and profitable. Because it won’t have to put its earnings to work building its reserves to meet the new 7% rule, Citigroup will be free to use its cash to buy back the stock it sold Uncle Sam during the bailouts, which could signal the bank’s return to its pre-financial crisis state of good health (with a few lessons learned — I’d argue the bank has seen the folly of piling on more and more risk and has become somewhat more disciplined about managing costs). The stock is a steal under $4.
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