Bank Bill to Bring More Competition, M&A
The regulatory relief fits our previous outlook and won’t materially change our bank valuations.
As expected, President Donald Trump signed regulatory relief for banks into law on May 24. Because the legislation needed the support of both Republicans and Democrats, a middle ground was needed, so the bill made only moderate changes to existing regulations, most notably leaving the Consumer Financial Protection Bureau alone. Overall, the benefits from regulatory relief fit well within our previous projections, and we are not making any material changes to our fair value estimates for the companies we cover.
One of the primary benefits we see of a less stringent regulatory environment will be the ability to shed excess capital and increase leverage. For the traditional banks we cover, over the next five years we project an increase in leverage of roughly 5% on average (as measured by equity/assets) and an increase in returns on equity of more than 20%, with roughly one fourth of this increase coming from the rising leverage. We do not plan to make any changes to our economic moat ratings based on the passing of this bill, as we believe that over the longer term, the economic benefits of the law will be shared and competed away to some degree, and the gains we currently project are already accounted for in our current ratings.
The legislation was aimed at benefiting primarily smaller banks, but we see two key benefits for the larger banks as well.
First, the trust banks, and potentially even the larger banks with trust operations ( JPMorgan Chase (JPM) and Citigroup (C)), will benefit from easing of supplementary leverage ratio regulations. The supplementary leverage ratio calculates Tier 1 capital divided by total leverage exposure (including off-balance-sheet exposure) to arrive at a non-risk-adjusted leverage ratio for a bank. This is used in conjunction with risk-adjusted leverage ratios, most notably the common equity Tier 1 ratio, to ensure that banks are not becoming overleveraged. The current changes will eliminate funds stored at central banks from the total leverage exposure calculation. This means that these funds, which are essentially considered riskless, will now have a risk weighting of zero, whereas before every asset had an equal risk weighting of 100%. This will improve banks’ supplementary leverage ratios and allow them to leverage up to a greater degree, most likely through purchasing higher-yielding securities. If the extra room for leverage allowed by these changes is simply invested into a like securities basket, revenue should go up for the trust banks by a range of 4% to more than 6%, all else equal.
Second, the bill raises the threshold to be designated a systemically important financial institution from $50 billion to $250 billion in assets. For banks with $50 billion-$100 billion in assets, this relief would be immediate (under our coverage: Comerica (CMA), Zions Bancorp (ZION), and SVB Financial (SIVB)). The Federal Reserve would be able to craft custom responses for banks with $100 billion-$250 billion in assets (under our coverage: BB&T (BBT), SunTrust (STI), Fifth Third Bancorp (FITB), KeyCorp (KEY), Regions Financial (RF), M&T Bank (MTB), and Huntington Bancshares (HBAN)). This would free these banks from the current enhanced prudential standards to which they are subject, including enhanced reporting, liquidity, resolution planning, and stress testing requirements. In our view, the most significant changes for these banks will be increased flexibility in capital return planning due to the lack of yearly stress tests, some cost savings on the margin (although the initial buildup costs for these compliance systems have already taken place), and the potential for some additional income from slightly relaxed leverage/liquidity requirements, although this effect should be minimal. We would expect increased room for more aggressive dividend and share-buyback policies as well as for mergers and acquisitions, particularly given the less stringent appointees the current administration is favoring.
We would not be surprised to see more deals like the recently announced acquisition of MB Financial by Fifth Third, in which a midsize regional bank acquires a smaller player to gain scale in key markets and move up the superregional size ladder. Given the recent increases in overall bank valuations, we do not expect these deals to come at bargain prices in the current environment. The largest banks are already so large that either they are explicitly forbidden from further banking acquisitions, or one that would move the needle significantly would probably not be approved. Instead, we see these banks (mainly the big four plus U.S. Bancorp (USB), PNC Financial Services (PNC), and Capital One Financial (COF)) focusing on organic growth, thereby increasing competition within their markets. Further, with so much momentum and record profits in the banking industry, we expect competition to pick up in general regardless, both for loans and for deposits, as the current cycle continues to mature. This, along with the eventual turning of the credit cycle, should provide some counterbalancing effects on returns over the next three to five years.
Eric Compton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.