What Regulatory Rollback Could Mean for Financials

We note that most discussion to date has been focused on easing the regulatory burden on smaller banks, not the Wall Street giants. The Financial CHOICE legislation introduced by Republicans contains its own restrictions on “too big to fail” firms and systemic risk and appears to favor “simplicity.” Thus, the various provisions and rules governing systemically important firms may not be a high priority for change.

In general, we agree that some features of the Dodd-Frank Act are somewhat unnecessary due to changes in the industry. Low-documentation subprime loans are unlikely to come back anytime soon, as the speculative excesses that drove demand from both homebuyers and investors are long gone. However, the new administration’s plans for Fannie Mae and Freddie Mac will have a much bigger effect on the mortgage industry.

Republicans seem set on neutering the Consumer Financial Protection Bureau as well, though it will remain in some form unless Dodd-Frank is fully repealed. Even in that case, the Financial CHOICE Act proposes adding a pro-market mandate to the bureau’s consumer protection functions rather than eliminating it or its consumer protection functions. Furthermore, the same proposal advocates enhanced penalties for financial fraud and corruption. Overall, we suspect the nation’s biggest banks will not be first in line for regulatory relief.

For our regional banking coverage, several items are likely to have an impact. One of the reform possibilities would be raising the Comprehensive Capital Analysis and Review threshold from $50 billion in assets to something higher, potentially as much as $250 billion. This would in theory decrease the explicit costs associated with this process for all regionals that have between $50 billion and $250 billion in assets, which is most of our regional coverage. However, we would note that this benefit could be smaller than some are expecting for the banks that have been above $50 billion in assets for several years already, which includes all the regionals under our coverage that are currently above $50 billion. Many of the processes associated with Comprehensive Capital Analysis and Review (CCAR) have already been built out for these banks, reducing the potential reduction in explicit costs. We do believe a combination of an easing of stress-testing methodologies, reduced regulatory stringency regarding approval of acquisitions, and clarity on future tax rates could all be a boon for M&A among banks.

While decreased regulatory burdens should be beneficial, we also note some proposals that suggest increasing capital requirements as an offset for decreased regulation. The Financial CHOICE Act suggests a leverage ratio of 10%. The majority of banks we cover have already met this requirement or are within 100 basis points. If banks choose this route, increased capital could at least partially offset an otherwise decreased regulatory burden.

Finally, we believe the talk of regulations alone limiting credit and growth is a bit one-sided. Many banks decided independently to increase credit standards, which is a natural part of the credit cycle after a downturn. There was also less demand for credit from clients, regardless of the willingness to lend. We see a continued pickup in consumer and corporate lending as credit demand increases and as standards ease gradually with the credit cycle progressing, independent of what is likely to be drawn-out regulatory reform.

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