Exploring the Impact of Leveraging Excess Capital in Driving EPS
By Mel Fabrikant Monday, September 09, 2013, 03:54 PM EDT
The emergence of more onerous regulatory capital requirements presents a myriad of challenges for the industry; however, a number of institutions maintain well in excess of acceptable capital levels and have the potential to drive EPS and ROE significantly higher. In this edition of the Bank Weekly, we have quantified EPS potential with excess capital fully deployed and provided specific commentary for those that stand to gain the most.
Updated Capital Rules. The July approval of a joint-U.S. regulatory stance on the implementation of Basel III has provided the industry much needed clarity on required capital levels. Largely perceived as a less burdensome outcome for smaller community banks than initially expected, the finalized proposal provides, among other items, individual institutions the optionality (instead of requiring) to include unrealized gains/losses tied to AFS securities portfolio within regulatory capital. Recent earnings conference calls and dialogue with management generally suggest current capital allocations should be sufficient upon the effective date of the ruling on July 1, 2015. Stress tests conducted earlier this year indicate larger institutions appear adequately capitalized under the new rules and are likely capable of absorbing another downturn in the credit cycle. On the other end of the spectrum, a number of SMID cap institutions possess capital levels well in excess of required minimums under Basel III and remain challenged in profitably deploying excess capital. While visibility of excess capital deployment via potential M&A and/or organic growth remains limited in our view for a majority of institutions with >10% TCE, a handful of SMID cap banks have demonstrated the earnings growth potential when capital levels return to a more "normalized" range.
Current Capital Dynamics. Since bottoming at 6.5% in 2007 (decade low), SMID cap bank median tangible common equity (TCE) levels have increased more than 200bp to 8.6% of tangible assets (as of 2Q13) with the large majority of institutions fortifying balance sheets as revised statutory capital regulations emerged and credit quality issues permeated throughout the industry. Similarly, the median regulatory tier-1 common capital and total risk-based capital ratios for SMID cap banks have increased to 12.2% and 15.2%, respectively, up from cyclical lows of 8.5% and 11.7% in 2008. Subsequently, most are challenged to accretively deploy excess capital going forward.
Screen of the Week. Utilizing 2Q13 GAAP data, we screened banks >$500 million in market cap with >10% TCE/TA to gauge the dollar amount of excess capital at each institution. We considered TCE above 8% of tangible assets to be "excess" capital. Assuming all "excess" capital could be leveraged to 8.5% and the Company can generate its projected 2014 ROA on the incremental asset growth, we estimated the additional earnings that could be generated. Based on this methodology, we found 20 banks that are currently trading hands for a 33% discount (median) to their current FY14E P/E, assuming "excess" capital gets fully deployed. Names that screened at the top of the list include: NBHC, CFFN, ORIT, CPF, CBF, HAFC and VPFG. On the following pages we provide company specific commentary, as well as pro forma EPS and stock price projections under various capital deployment scenarios.