By Matthias Rieker 
 

Several regional banks are offering a first glimpse into their capital ratios according to new rules proposed last month by the Federal Reserve, and shareholders don't like what they are seeing.

The recent selloff in bank stocks illustrates how much investors have come to rely on dividends and share buybacks for their returns, rather than on banks' ability to expand and grow profits. Any hint that banks' ability to return capital to shareholders could be in doubt is therefore disconcerting.

"Investors are worried," said Andrew Boord, a portfolio manager with Fenimore Asset Management Inc. Never mind that most of the new capital rules would take affect between 2015 and 2019. "Investors are not in the mood to think that far out or trust management either," Mr. Boord said. "Many investors are worn out from investing in banks--it is just one issue after another. Exhaustion hinders patience in situations like this."

Boutique investment bank Evercore Partners Inc. has calculated that the average impact from the Fed's new capital rules would be a decline of 207 basis points in Tier 1 capital ratios for large banks, and a decline of 157 basis points for regional banks. Second-quarter earnings, meanwhile, were "slightly better than expected," the firm said in a research report.

First Horizon National Corp. (FHN) said the new rules would shave 240 basis points off its current 10.6% Tier 1 common capital ratio. Its stock is down about 6.3% since its earnings release. Other banks have seen their share prices decline since releasing earnings: TCF Financial Corp.'s (TCB) stock is down 12%; it said its capital would decline by 146 basis points; BB&T Corp.'s (BBT) capital would take a hit of 150 basis points, and its stock is off about 1%.

What is troublesome for investors is this: The banks that disclosed the hardest hit were also the ones investors considered to be the banks that would return the most capital through buybacks, said RBC Capital Markets analyst Gerard Cassidy. "The market overreacted because I feel the banks will push back hard," he said in an email. The comment period on the rules ends September 7.

In a research report, Mr. Cassidy said bank capital under current rules "continue to exhibit superior strength," and "most banks" will exceed their capital ratios under the new rules "by the end of this year and, for the banks that do not exceed the target this year, we believe they will by year end 2013."

Concerns about capital have abated since banks rebuilt capital depleted by defaulting loans during the financial meltdown. According to Keefe, Bruyette & Woods Inc., banks raised more than $172 billion in equity since 2007, in many cause diluting shareholder's return and ownership.

Investors don't fear more dilution, said Keefe Bruyette's director of research Frederick Cannon. But some of the banks that worried investors last week will have to go through their first stress test next year, and regulators' review of the test worries investors. Investors concluded their hopes that banks would increase dividends and buybacks beyond current expectations might be shattered, he said.

Last month, the Fed proposed that all banks, large and small, obey the same standards, which are in line with the rules knows as Basel III, agree upon by the Basel Committee on Banking Supervision. The proposal is open to comment but, if adopted, would demand banks hold common equity equal to 4.5% of their "risk-weighted assets," plus an additional 2.5% "capital conservation buffer," also of common equity. This total 7% common-equity cushion compares to current standards of as little as roughly 2%.

Bankers said they have not only the time but also the means to mitigate the impact from the new capital rules. They can reduce loans that weigh on capital, such as construction loans; charge more for the kinds of loans that will be affected, such as commercial loans and lines of credit made by banks but not drawn by borrowers; or change terms for home-equity lines of credit, which would also be affected by the new rules.

"We just need to tweak our rules just a little bit in how we underwrite" loans, BB&T Chief Financial Officer Daryl Bible said during a conference call with investors last week.

Bryan Jordan, First Horizon's chief executive, said last week: "We expect to still have strong generation of capital and the ability to repatriate capital to our shareholders."

Write to Matthias Rieker at matthias.rieker@dowjones.com.

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