Trends: What does Dodd Frank mean for US banks?

The US banking system enjoyed a strong year in 2016. Net income rose 4.9 per cent to an all-time high of $171bn, according to the Federal Deposit Insurance Corporation – while a 9.34 per cent return-on-equity in Q4 2016 was the highest fourth-quarter return since 2013.

The positive narrative remains broadly intact, with sound loan growth, controlled expenses and accelerating share repurchases. Expected revenue growth of more than 3.5 per cent in 2017 is set to cap off a third consecutive year of revenue growth.

The focus for this year will be on the trends related to revenues, expenses, credit quality and capital. Is it all fine and dandy? There is one big elephant in the room – namely how the four factors above could be affected directly or indirectly by plans to rewrite or repeal the Dodd Frank Act, which was passed into law in 2010.

In February, President Donald Trump kicked off attempts to unwind parts of the Obama-era regulatory regime by signing an executive order to review Dodd Frank. The rules will be assessed on how they fit with certain principles, including “fostering economic growth, preventing taxpayer funded bailouts and enabling US firms to be competitive with foreign counterparts and…advance American interests in international financial regulatory negotiations and meetings”.

From a credit perspective, when assessing speculation in the press and statements from members of the US administration, some of the touted proposals would be positive, while others could have secondary effects.

US banks on average have more than 15 per cent of their balance sheets in high liquid assets. Those are bullet-proof government bonds, GSE securities and state-guaranteed bonds.

However, these holdings offer low yields and have contributed to a contraction of bank net interest incomes. A relaxing of these liquidity rules could be beneficial to bank profitability.

A dialling back on the Durbin amendment, which caps credit card interchange fees, could also be positive – as it has resulted in almost $10bn of lost revenues to money centre banks.

Reviewing the proprietary trading ban and market-making activities of banks – the so-called Volcker rule – could have a positive impact on the profit and loss of banks, but most importantly, could alleviate the market illiquidity pressures witnessed since the rule was enforced.
Raising the threshold for systemically important financial institutions (SIFI) from $50bn to $250bn would also be positive for mid-size banks – such as CIT Group and Ally Financial.

SIFIs face stringent supervision by the Federal Reserve. However, the abolition of the annual Federal Reserve’s stress test, entitled the Comprehensive Capital Analysis and Review, would not be a good idea. Investors have acquired a good deal of granular information on the quality of bank assets, as well as sensitivity to rate moves or market shocks, from this data. Losing this wealth of information will mean it will be time-consuming for analysts to obtain.

Overall, we expect US banks to benefit from an improving earnings backdrop – with higher rates and steeper curves – as well as enjoy continued balance sheet strength.

Filippo Alloatti is senior credit analyst at Hermes