Regional bank executives are bracing for tougher rules after Silicon Valley Bank’s failure, but they’re also hoping regulators take a measured approach and move slowly.
In earnings calls this month, executives of banks with more than $100 billion of assets appeared resigned to the fact that more regulations are coming. Some said they’re holding off on share buybacks until they get more clarity on what those rules will look like. And while they said they’re prepared for any regulatory changes, bankers are hoping they’re phased in so that the impact isn’t sudden.
“You can’t move too fast because we all can’t go out there and raise a bunch of debt at the same time. It would be tough for the market to absorb,” said David Turner, the chief financial officer at Birmingham, Alabama-based Regions Financial, referring to an expected change that would prompt banks to raise long-term debt to cushion the blow of losses.
Bruce Van Saun, CEO of Providence, Rhode Island-based Citizens Financial Group, said it’s “clear that some changes will occur.” But he questioned whether the answer to last month’s failures of tech-heavy Silicon Valley Bank and crypto-friendly Signature Bank is “more regulation on regional banks.” He noted that those two banks had far different customer bases than most regionals, and he also argued that the banks’ supervisors “didn’t really do their job.”
“Our hope is that the response is thoughtful and appropriate, leaving the bank landscape that has served our country so well intact and even stronger than before,” Van Saun said.
More clarity on the issue may come next week, when the Federal Reserve is set to release its review of potential shortcomings in its oversight of Silicon Valley Bank. The Santa Clara, California-based bank had more than $200 billion of assets before a run from depositors led to the second largest bank failure in U.S. history.
Banking trade groups have been pushing back against the need for more regulation, saying the failed banks had “idiosyncratic” business models and clients concentrated in one sector. The groups have argued that the fault lay with both bank managers and their supervisors — not the rules that apply to banks with more than $100 billion of assets.
Congress and federal regulators loosened those rules under the Trump administration, a shift that some bank critics say contributed to Silicon Valley Bank’s failure.
Those rules are now poised to get stricter again. Fed Vice Chair for Supervision Michael Barr told Congress last month that he saw a “need to strengthen capital and liquidity standards for firms over $100 billion,” while noting that regulatory agencies would need to go through the formal rulemaking process.
Rulemaking can be slow, with public comment periods and phase-ins that give banks time to prepare for changes, some bank executives pointed out in earnings calls. But regulators are “not starting from scratch” like they did after the 2008 financial crisis, making it more likely that tougher rules will come quicker, said Isaac Boltansky, director of policy research at BTIG.
On the other hand, regulators will likely keep in mind that rapid changes could prompt more stress in markets, where worries have persisted over some banks’ health.
“I think that the regulatory regime is going to be much tougher,” Boltansky said. “I do think, however, there’s going to be an awareness that turning these dials too aggressively right now could have unintended consequences for the economy and the functioning of the banking system.”
Bank stress tests are one area that regulators may revise, though the precise contours of any changes are unclear, Boltansky and other analysts said. In 2019, the Fed allowed banks with between $100 billion and $250 billion of assets to undergo stress tests every two years. Regulators may decide to put banks on an annual cycle again.
The Fed is also likely to start testing banks against a variety of scenarios, according to Jaret Seiberg, an analyst at TD Cowen. The regulators’ recent stress tests focused on how banks would fare under a severe hypothetical downturn that would bring about near-zero interest rates. But recent exams have not tested the banks’ resilience to higher interest rates — an eventuality that played a key role in Silicon Valley Bank’s failure.
Last month, Barr told Congress that the Fed needs to “enhance our stress testing with multiple scenarios so that it captures a wider range of risk.” In one such example, the Fed added a market shock scenario for megabanks in this year’s stress tests that is only exploratory and will not play a role in their capital requirements.
Regulators also loosened liquidity requirements for banks in their 2019 changes. As a result, banks with $100 billion to $250 billion of assets are generally no longer required to meet the liquidity coverage ratio. This rule, known as the LCR, requires larger banks to hold high-quality liquid assets that they can easily shed to survive a period of significant cash outflows.
The country’s largest banks, such as JPMorgan Chase and Bank of America, are subject to the full version of the LCR. Super-regional banks with between $250 billion and $700 billion of assets, such as Truist Financial, are generally subject to a reduced version of the LCR depending on the amount of short-term wholesale funding they have.
Those banks may now see a full LCR again, while smaller regional banks may once again be subject to the LCR. Those banks include Citizens Financial, which has $222.2 billion of assets, though the bank’s executives said its liquidity already exceeds the levels required of some of its larger peers.
“I think we’re in good position,” Van Saun said, pointing to “very rigorous internal liquidity stress testing” at the bank and saying that it has managed its balance sheet conservatively.
While tougher LCR requirements may not lead to massive costs, there may be indirect impacts, said David Konrad, an analyst at Keefe, Bruyette & Woods. Mortgage-backed securities issued by Fannie Mae and Freddie Mac get a slight penalty under the LCR rule, so banks may back off a bit from buying them.
“Banks have really been large buyers of mortgage-backed securities, and that might be tougher in the new world, to put that on your balance sheet,” Konrad said. He added that a pullback by banks might lead to higher mortgage rates.
Regulators are also weighing scrapping an exemption for regional banks that shields the swings in their bond portfolios from impacting their regulatory capital, according to The Wall Street Journal.
Securities that banks classify as “available-for-sale” can accumulate gains when interest rates fall or absorb losses when rates rise. Those changes are factored into megabanks’ regulatory capital levels, which last year prompted them to take a more cautious approach on buying back their shares since their capital levels had fallen.
Banks with less than $700 billion of assets were allowed to opt out of having their bond portfolios’ income hit their regulatory capital, an exemption that regulators may now walk back.
That opt-out masked some of the “unrealized” losses on Silicon Valley Bank’s bond portfolio, but it would not have captured the vast majority of the bank’s bond losses. That’s because Silicon Valley Bank had put most of its bonds into its “held-to-maturity” portfolio, where quarterly swings are not factored into regulatory capital at any bank.
Seiberg, the TD Cowen analyst, wrote in a research note that he does not expect regulators to change how banks handle their held-to-maturity portfolios. Regulators will instead look to ensure that “banks have the ability to meet liquidity needs without tapping this portfolio,” since selling any part of the held-to-maturity portfolio will lead regulators to view the entire bucket as tainted, he wrote.
But regulators are likely to repeal the exemption for available-for-sale securities at regional banks, Seiberg wrote. That would lead to a capital hit at those banks, though phasing in the rule would limit the impact, he added.
Without an adequate phase-in period, some banks may be forced to raise capital and may spook investors when they do so, said Scott Siefers, an analyst at Piper Sandler. “That can lead to the impression that the system is not capitalized appropriately, which in and of itself can hurt confidence,” Siefers said.
Executives at Cleveland-based KeyCorp, which has $197.5 billion in assets, said the company’s strong earnings performance will “allow us to organically” build capital to higher levels if needed. For now, the company has paused its share buybacks and won’t plan on resuming them until there’s clarity on new capital rules, CEO Chris Gorman said.
Pittsburgh-based PNC is also being cautious on share repurchases, according to CEO William Demchak, who said the company is “well positioned” to deal with the regulatory changes under discussion. Those ideas include an elimination of the opt-out for bond portfolio values, along with a new total loss-absorbing capacity, or TLAC, rule that regulators had been eyeing for regional banks before Silicon Valley Bank failed.
TLAC rules are a “certainty at this point,” Demchak said, and the only question is whether they will be less stringent depending on the size of a bank. “I don’t see any issue coming out of regulation that we won’t be able to handle in the due course,” he said.