by Danielle Robinson

NEW YORK, July 1 (IFR) - Bank of America Corp's decision to resolve $14 billion worth of mortgage backed securities-related liabilities might have boosted its stock and bond prices, but it has put it further behind its peers in the race to build up enough capital to be Basel III compliant.

BofA this week announced a settlement, still pending court approval, that makes changes to servicing practices and an $8.5 billion payment to the trustee, for 530 legacy Countrywide RMBS trusts.

Bank of America CEO, Brian Moynihan, said the sizable charge the bank is taking will impact Tier 1 ratios by about 50bp under Basel I standards. Analysts were told the expectation was for BofA to hold core Tier 1 common equity capital equivalent to 6.75%-7% of its risk-weighted assets (RWA) by the beginning of 2013.

That compares with Citigroup's expectations of having around an 8-9% Tier 1 common equity ratio by that time. JPMorgan says it is already at 7.3% common Tier 1 under Basel III guidelines and analysts expect it will be around 10% by the start of 2013.

According to Goldman Sachs, all of the largest US banks except Citi and BofA are today at or above a 7% Tier 1 common equity ratio on a fully-phased in Basel III basis, even though they don't have to even start implementing Basel III guidelines until January 2013. Citi is currently estimated to be around 6.1% and BofA around 5.4% under Basel III.

It doesn't have to be a race. Most analysts expect all of the largest US banks to be compliant by the 2019 implementation deadline if the Fed requires them to abide by all of the Basel III capital requirements, including the additional 1-2.5% Tier 1 common equity surcharge systemically important banks (G-SIBS) need. And that's without having to issue equity.

But in a world where markets and regulators are obsessed with bank strength - and Tier 1 capital being one of the most focused-upon gauges of strength - bankers and analysts argue that no-one wants to be the slowest to get there.

We peg BofA's current Tier 1 common ratio under Basel III at 5.5% versus JPM and (Wells Fargo) at over 7%, said Jason Goldberg, a senior Barclays Capital equity analyst. We wonder if this difference is sustainable.

By sustainable, Goldberg is referring to whether shareholders will be patient with BofA or any bank if there's a persistently large gap between it and its peers in getting to Basel III compliance on capital.

Pressure could come on a bank's stock if it seems to be having a harder time meeting the new capital requirements as quickly as its peers. That's because its slowness could imply the bank will have to retain more earnings and have less ability to buy back shares and increase dividend payments in the future.

Banks have to get there sooner, added a financial institutions group banker about reaching Basel III guidelines by 2019. That's because of the equity pressure on banks to say to the market that they have the adequate capital. As we all know there is a race among the banks to not be the one singled out as having an issue with this.

Normally a bank would be better off phasing the new capital ratios in over time. But in this environment it is all optics, said the FIG banker. You have to say you can get to levels ahead of time because the view is it will make big clients think of you as the strongest and best bank to give their business to.

Although a bank's stock price and bonds spreads are rarely correlated, bankers say enough noise around the stock has the potential to trickle into the credit markets and cause a bank's funding costs to rise.

Goldberg at Barclays believes BofA's 'capital redeployment' - giving shareholders value through dividend increases and share buybacks - will now be constrained for the foreseeable future, longer than its peers.

BofA has the ability to pick up the pace by retaining earnings and speeding up the 'mitigation' process, which involves shrinking RWA and freeing up capital through various measures.

Morgan Stanley analyst Betsy Graseck, argues that BofA can get to a 10% Basel III common equity Tier 1 ratio in 2013 sometime.

Over the next three years, we expect 300bp to come from earnings, 110bp from RWA shrinkage, 110bp from reduced capital deductions, 40bp from a gain on CCB's (China Construction Bank) sale and another 40bp from other methods, said Graseck in a recent report.

It's not just an unofficial race among competitors that's putting pressure on banks to get to Basel III compliance as quickly as possible.

The Bank for International Settlements (BIS) has said that banks should be pushed to meet the higher capital requirements before the series of phase-in deadlines start in 2013, as long as it doesn't affect a bank's ability to lend.

Countries should move faster if their banks are profitable and are able to apply the standards without having to restrict credit, the Basel-based BIS said in its latest annual report. The BIS is the parent organization of the Basel Committee.

If they want to immediately get to 9.5% - the 7% minimum and the 2.5% G-SIB surcharge they're likely to need - Barclays estimates Wells Fargo, JPM, Citi and BofA would need about $175bn of extra capital. That's before mitigation actions they could take.

In reality the biggest banks might decide to have an extra 50bp more Tier 1 common equity than the 7% minimum and the likely 2.5% G-SIB surcharge.

Given the need to have some room above the required capital levels due to potential volatility of other comprehensive income, we are modeling these companies (Citi, BOFA and JPM) to a target tier 1 common ratio near 10%, said Keefe, Bruyette & Woods analysts in a recent report. It is doing the same for Goldman Sachs and Morgan Stanley.

Basel III also calls for an additional 1.5% of non-common equity Tier 1, bringing the biggest banks' total Tier 1 capital needs up to a potential 11% and possibly 11.5% if they want to have the extra 50bp so they're not skating on the edge of the minimums.

The exact requirements, and what instruments can be used to fill them, will be outlined by the Fed in the late summer/early fall when it's expected to issue a notice of proposed rulemaking on how US banks should implement Basel III.

The battle then is expected to be focused on stopping the Fed from imposing any further capital buffers.

The arguments will center on the fact that Dodd-Frank regulations will impose additional costs and anti-competitive constraints on the US banks that their global competitors currently don't face. They are also likely to point out that the US's calculation of risk weighted assets is stricter than what it is in Europe.

(Danielle Robinson is a senior IFR analyst)