Thought of the day
03.08 - Banking on deregulation
The S&P financial sector index regained its pre-crisis highs this week, partly driven by expectations for financial sector deregulation. A three-agency regulatory report warning of “aggressive projections” used by US lenders to approve loans to already highly leveraged companies suggests that some of the optimism about deregulation may be misplaced.
But a closer inspection suggests little cause for investor concern, and the prospect of regulatory-driven change alongside improving economics should lift US bank shares higher still:
- The same report suggests the number of corporate borrowers (ex-oil and gas) with leverage of 6x or more has fallen to 30% this year, from 42% in 2014, a significant improvement. It also showed the relative number of “adversely risk rated commitments” from lenders has declined to 8.1% from 11.1% over the same time frame.
- President Trump is less constrained with banking policy compared with other reforms. We estimate two-thirds of the regulatory changes proposed by Treasury Secretary Steven Mnuchin in June can be implemented without legislation. The Volcker Rule, designed to limit propriety trading in commercial banks, is already being reworked by five key US regulators.
- Banks have not raised rates on deposits despite the increase in the fed funds rate, but are benefiting from the rise in longer-term lending rates. The effective yield curve for US banks has steepened over the last year, which supports earnings.
We maintain our moderate overweight position on US financials, with regulatory changes likely to help lower compliance costs and boost capital returns across the banking sector. We still prefer consumer-focused banks and diversified financials.