That surge in Bank of America’s (BAC) Basel III capital ratio didn’t come the old-fashioned way.
After taking a $1.6 billion hit to settle a lawsuit, the company paid more in dividends than it eked out in net income in the third quarter, so it didn’t build its equity buffer by retaining earnings. Instead, interest rates moved B of A’s way and credit spreads improved, leading to the one-percentage-point jump from a year earlier. At an estimated Tier 1 common ratio of 8.97%
The outturn means that B of A has posted the highest estimated Basel III ratio among the Big Four for two consecutive quarters, a remarkable development for a company whose shares traded below $6 as recently as last year on doubts about its ability to survive.
Investors still have their doubts, of course. B of A’s stock price continues to trade at a discount to tangible equity, while JPMorgan Chase (JPM) and Wells Fargo (WFC) sell at premiums. None of these megabanks has reserved enough to cover a hypothetical meteor strike in the form of a massive judgment over bad mortgage assets sold during the bubble.
Nevertheless, the behavior of Basel III ratios, and their potential for volatility, is coming into clearer focus as more banks have begun to provide specific estimates in advance of the implementation of the latest version of international capital regulations.
Of the 87-basis-point increase in its ratio from the second quarter, B of A said about a quarter, or 21 basis points, came from low interest rates that boosted the value of a pool of securities by $3 billion. Changes in the market value of certain securities are not reflected in net income or current measures of regulatory capital, but would count under Basel III. (In accounting terminology, such changes are captured under “other comprehensive income,” or OCI.)
Meanwhile, in the denominator, B of A’s risk-weighted assets fell by $65 billion in the third quarter to $1.5 trillion. The company said about half this reflected runoff of consumer loans and tightening in credit spreads.
To be fair, B of A was also on the wrong side of some escalator-rises-as-it-falls accounting in the third quarter: it absorbed a $1.9 billion loss due to strengthening in its own credit spreads. Moreover, capital ratios are still fundamentally driven by profits, losses and capital offerings, and B of A raised tens of billions of dollars from private investors after the crisis.
Besides, the prospect of swings in bond values can serve to clarify some risks.
Referring to the possibility that yields could climb and hammer investment portfolios, Bruce Thompson, B of A’s chief financial officer, told investors in October, “One of the things that we are not going to do in this rate environment is stretch for yield and create an OCI problem under Basel III.”
