By Kush Goel, Research Analyst, Global Equity Research
What are the implications of the presidential race for the beleaguered banking sector?
As we enter the final phase of the U.S. presidential election, it's worth considering the impact that the results could have on the banking industry, which has been the focus of considerable political and popular anger since the global financial crisis of 2008.
In doing so, it's important to point out that this is not a homogeneous industry. There are still over 6,000 banks in the U.S., and most of them are small community banks. The public, political and regulatory ire is actually directed towards a handful of the largest banks - the so-called GSIBs (global systemically important banks) and some other institutions. The eight U.S. GSIBs are largely "Wall Street" firms such as Bank of America (NYSE:BAC), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), JPMorgan Chase (NYSE:JPM) and Morgan Stanley (NYSE:MS). This is a group that gets the most press and is the focus of this Sector Spotlight.
- The very largest banks are focus of public ire
- Sanders' exit means political risks have eased
- Trump could work to roll back Dodd-Frank
- Clinton would likely govern from the middle, but Warren's role is a wild card
- All eyes are on regulators, not legislators
- Economic fundamentals will be key to stocks' prospects moving forward
Sanders Defeat Makes for Potentially Clearer Sailing
With Bernie Sanders out of the race, political risks have eased somewhat for the group. Sanders famously said that "business model of Wall Street is fraud," and he has been vocal about breaking up the largest banks. In contrast, we don't think Donald Trump or Hillary Clinton are strongly against Wall Street beyond the general dislike that politicians have shown for the group.
The Republicans under Trump could potentially roll back parts of the Dodd-Frank law (the signature piece of post-crisis legislation passed in 2010), which would be positive for the group. However, surprisingly, the recently released GOP platform also supports the reinstatement of the Glass-Steagall Act, the Depression era legislation that led to the separation of commercial and investment banking activities.
This seems more like a last minute attempt to appeal to Sanders' supporters, and only gets a single line's mention in the document. Still, it does create uncertainty about whether Trump might pursue breaking up the largest banks; an outcome that we believe is unlikely.
Regulators, Not Legislators, Are Likely to be the Key Drivers
Still, the markets haven't really been too concerned about the impact of the elections on banks because we see most change in the industry now being driven by regulators rather than legislators. As far as legislation is concerned, Dodd-Frank is already considered a very tough law, the regulators are in the process of implementing it, and there appears to be little appetite in either party to make it more onerous; if anything, there could be changes to ease the burden on smaller banks.
Meanwhile, most of the crisis-era federal litigation has been worked through by the Justice Department. We do not expect a new administration from either party will discover major transgressions from that period that haven't already been prosecuted.
Regulators are pushing through important changes in the U.S. and on a global basis, though we appear to be moving towards the end of this process as well. In the U.S., this group consists of the Federal Reserve and several other agencies (including the FDIC, OCC, SEC, CFTC, CFPB, FHA and NCUA). Globally, central bankers coordinate their actions in Basel, Switzerland. The largest banks now have to manage a veritable alphabet soup of new requirements on capital (CET1, SLR, CCAR), liquidity (LCR, NSFR), resolution (TLAC) and safety (Volcker rule, leveraged lending).
These have already had a massive impact on the amount of capital and liquidity that the industry holds, curtailed the ability to engage in certain activities legislators deemed too risky, and we believe improved the safety and soundness of these institutions. Unfortunately, this could all have the effect of meaningfully lowering the profitability of these institutions.
On an ongoing basis, the large banks are most affected by the Comprehensive Capital Analysis and Review (or CCAR), which is the Federal Reserve annual stress test that has been in effect for five years and is used to control the capital plans of the group (including dividend, share repurchase and acquisition plans). The CCAR is both a quantitative and a qualitative test and is designed to be opaque, all of which gives the Fed tremendous power to force change - to capital, business model, management and more - at the covered banks; the test has resulted in the large banks being required to hold more capital each year.
One way the election could impact industry conditions relates to the head of this effort, Fed Governor Dan Tarullo, who has been very tough on the banks. Some believe that a Trump victory could prompt Tarullo to leave prior to the end of his term in 2022 and be replaced by a new appointee who might be "friendlier" to financial institutions.
More Fundamentals than Politics
It's hard to anticipate if and when the public's attitude could soften towards the large banks and Wall Street. However, the group has already absorbed the effects of this anger, and it's hard to believe that sentiment could get any worse. From an earnings and growth perspective, the more important impact under a new president is likely to be how well the economy performs and the implications for interest rates, loan growth and the risk appetite of individuals and corporations. In other words, whether or not the noise continues, we believe it will likely be fundamentals that make the ultimate difference.
This material is provided for informational purposes only. Nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This material is not intended as a formal research report and should not be relied upon as a basis for making an investment decision. The firm, its employees and advisory clients may hold positions of companies within sectors discussed. Any views or opinions expressed may not reflect those of the firm as a whole. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Please see disclosures at the end of this publication, which are an important part of this article.
© 2009-2016 Neuberger Berman LLC. | All rights reserved