The Wall Street Journal
Who needs Congress? Not bank stocks.
President Trump's failure to get a health-care reform bill through the House of Representatives has raised fears that his broader agenda, from tax cuts to infrastructure stimulus, could be in jeopardy.
This has hit bank shares, among the biggest market winners since the election, in two ways. It chills overall expectations for the U.S. economy and interest rates, and undermines hopes for deregulation of the financial industry.
The latter concern shouldn't be overstated. Granted, it appears even less likely that this Congress will manage to pass a bill overhauling Dodd-Frank, the landmark postcrisis regulatory law.
As with health care, there are substantial ideological differences among Republicans on financial regulation. Moreover, Democrats would be able to block any such bill with a Senate filibuster.
But the administration has room to act on its own through its power to interpret and enforce financial regulations, and the results could be highly material for bank investors.
The Federal Reserve could start by removing the "gold plating" of capital requirements for the biggest banks. This would lower the capital surcharges that so-called global systemically important banks in the U.S. must hold, bringing them in line with peers in Europe and elsewhere.
Analysts at Keefe, Bruyette and Woods have estimated this would raise 2018 earnings per share by an average of 4.6% at the eight such mega banks in the U.S. That seems generous as it assumes they would fully redeploy freed-up capital in the first year, but it is a useful guide to how tweaks in capital requirements can juice profitability. Citigroup would be biggest beneficiary, seeing a nearly 10% boost to earnings.
Second, regulators could change the way they calculate banks' total leverage by not counting ultrasafe assets such as cash, U.S. Treasurys and deposits at the Fed in their leverage ratio. This would be even more powerful, raising 2018 EPS by 13.5% on average for the big eight banks, according to KBW estimates. Bank of New York Mellon and State Street, two trust banks with large securities portfolios, would benefit most.
An outright repeal of the Volcker rule, which bars proprietary trading by depository institutions, would boost 2018 EPS by an average of 4.2% at Bank of America, Citigroup, J.P. Morgan Chase and Morgan Stanley, according to estimates by analysts at Goldman Sachs, which of course would itself benefit. This would require an act of Congress, but something close could be accomplished simply by loosening enforcement of the rule.
Goldman analysts also note that regulators could change the liquidity classification of securities issued by Fannie Mae and Freddie Mac. Though these securities are widely traded, they don't count as much as Treasurys in helping banks reach the required level of highly liquid assets.
Removing this penalty would allow banks to hold more of these higher-yielding securities. That would boost 2018 EPS by an average of 2.5% at the biggest banks and by 1.8% at large regional banks, according to Goldman's estimates.
Bankers may hate Dodd-Frank but, because it delegates so much rule-making authority to the executive branch, the law's design might yet win fans on Wall Street.
This article was licensed through Dow Jones Direct.
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