As if there wasn’t enough reason to be bullish on them in the shadow of rising interest rates, Bank of America Corp (NYSE:BAC), Citigroup Inc (NYSE:C) and Wells Fargo & Co (NYSE:WFC) — along with all other bank stocks — could soon be enjoying an even stronger tailwind. How so? By the time you’re reading this, the U.S. bank regulations landscape could look considerably different than it has at any time since 2008’s subprime mortgage meltdown.
The matter is now in the hands of the nation’s House of Representatives. The House is expected to vote next week on a bill that will ease some of the most restrictive bank rules imposed by 2010’s Dodd-Frank Wall Street Reform and Consumer Protection Act… an act designed to make sure what happened in 2008 can’t happen again.
Lowering the Bar
The possible reform has gone largely unnoticed, even by owners of bank stocks who keep close tabs on potential changes to the country’s bank rules. Ongoing drama supplied by North Korea, along with the unceasing media coverage of the White House and the last bit of Q1’s earnings season have all made more noise.
Yet, it’s happened all the same. The nation’s Senators approved the rules rollback in March… with a rather sweeping margin of victory (67 to 31). The House is expected to vote on, and pass, S. 1255 within the next several days.
The gist of the bill in question is two-fold.
One tenet is a major raising of the bar that determines whether or not a particular bank is “systemically important,” and therefore subject to tougher bank regulations.
That threshold now stands at any bank with more than $50 billion in assets, but S. 1255 would raise the bar to $250 billion. That new threshold in and of itself wouldn’t change much for bank stocks like the aforementioned Wells Fargo or Bank of America, but it would take smaller names like SunTrust Banks, Inc. (NYSE:STI) and Fifth Third Bancorp (NASDAQ:FITB) out of the restrictive “too big to fail” circle.
The other key aspect of the impending legislation eases bank regulations for outfits of all sizes by lowering the leverage ratio for the entire industry.
The leverage ratio, in layman’s terms, is a limit on how much of a bank’s deposits can be lent back out to borrowers. The more money a bank has available to borrowers, and for other purposes, the more profit it makes. That requirement was raised following the subprime meltdown, which could have been well abated (even if not entirely avoided) has banks not been allowed to operate with such a thin cushion.
One of the key benefits of these pending rule changes is a community banking industry that aims to be more competitive with mega-banks — though that may not pan out.
Not Unanimous Support
While owners of bank stocks are clearly cheering for the House’s green-lighting of the revised bank rules, some observers are concerned — for the reasons one would expect. Namely, the bill pushes the industry right back into the risk-oriented mindset that’s proven problematic in the past.
Federal Reserve governor Lael Brainard was one of the dissenters. She recently commented: “Some observers contend that current capital requirements are too onerous and are choking off credit. But the evidence suggests otherwise: U.S. bank lending has been healthy over recent years and profits are strong,” justifying her ‘no’ vote to the proposed changes in bank rules.
The Federal Reserve doesn’t make law, of course, though a faction of lawmakers themselves have further criticized the bill and its passage. Most notable among those critics were Democratic Senator Elizabeth Warren and Independent Senator Bernie Sanders.
Other industry insiders and regulators have railed against the proposed rule changes as well, with some specific complaints about the underlying philosophy itself. Former head of the FDIC (at the helm in 2008) Sheila Bair is also against the proposed rules. She stated that, “The leverage ratio was a much better predictor of financial health of banks going into the crisis,” — suggesting it should be the ultimate arbiter on the matter and loosening the regulation could lead to a similar repeat crisis in the future.
It’s enough dissent to at least get the attention of bill’s supporters, even if not enough to shoot it down.
Bottom Line for Bank Stocks
It’s not enough dissent, however, to prevent the House’s passage of S. 1255, which the President is expected to sign.
Indeed, if anything, the proposed rule changes are actually more palatable because they’re a watered-down version of the plan several GOP leaders had in mind early on in this year’s legislative session. Though other unrelated bank rules are being drafted for a separate vote at a later date, their fate is less certain than S. 1255’s is.
Regardless, despite its criticisms, these new bank regulations will make bank stocks even more profitable. The question is, what happens when, not if, the economy runs into a cyclical headwind again? Though it’s unlikely we’ll ever see the kind of devastation we saw in 2008 again, the layers of protection put in place after the fact are indeed slowly being stripped away.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
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