Two years after Dodd-Frank Act (DFA) first made the law books, Standard & Poors (S&P) has revised its estimates on the cost of the regulations to the eight largest banks in the US given that much of the rules have yet to be written.
It now estimates that the DFA could reduce pretax earnings for the eight large, complex banks, namely Bank of America, Citigroup, Goldman Sachs, J.P. Morgan Chase, Morgan Stanley, PNC Financial Services, U.S. Bancorp, and Wells Fargo by a total of $22 billion to $34 billion annually higher than the ratings agencys prior estimate of $19.5 billion to $26 billion.
S&P first published its estimates in November 2010. At the time, it believed that the bulk of the new regulations would have taken effect within two years and would have an impact on bank results by 2012 or 2013. While many of the rules have yet to be written, many of those that are final have transition periods for their implementation that are longer than S&P originally expected.
S&P said while the financial impact of regulatory reform will not in itself affect S&Ps ratings of these institutions, it could change its risk assessments of banks business or risk positions.
On the plus side, though, banks loan-loss provisions have declined significantly over the past two years and S&P projects theyll continue to fall through at least 2016, which should benefit earnings.
The full impact of the regulations could mean a drop in pre-tax return on equity (ROE) of 250 basis points (bps) to 375 bps for the biggest banks again reflecting the view that regulators will take a more strict interpretation of the Volcker Rule than it previously expected.
Excluding the impact of regulations already in place (such as the Durbin Amendment and the new calculation method for deposit insurance), S&P estimates the potential reduction in pretax earnings would be $8.5 billion to $17.5 billion, or 90 bps to 195 bps on a projected pretax return on revenue basis based on full-year 2012 forecasts. Based on S&Ps projections for the group, this would mean ROEs of 8.8%-9.8% at current capital levels.
For comparison, S&P projects that these big banks will post a combined pretax ROE of about 11% and a pretax margin of 22% in 2012. Although projected pretax margins have improved somewhat from our last estimate, projected ROEs have declined, largely because of banks’ higher capital levels in order to comply with Basel III.
S&P has raised its estimate of the negative annual revenue impact of the Durbin Amendment, which allows the Federal Reserve to limit interchange (or “swipe”) fees that merchants pay to banks, on the largest banks to $5.4 billion from its previous estimate of $4.5 billion to $5 billion because the amendment has had a bigger effect than it anticipated. The final rule capped interchange fees at approximately $0.22 per transaction (plus other adjustments), up from the initial $0.12 limit, which banks argued didn’t allow them to cover their costsBased on historical derivative transactions, S&P continues to assume that 97% of derivatives can remain in (or move to) bank subsidiaries and that a large portion of these transactions will move to a clearinghouse. It also assumes that greater pricing transparency and margin requirements for the business that moves to clearinghouses will cut margins for that business in half, to about 16%-17%. However, we don’t assume that the regulation will cause a significant change in derivatives volumes.
The Federal Deposit Insurance Corp. (FDIC) expects to propose a rule to increase the assessment on banks with consolidated assets greater than $10 billion to make up the funding gap. This higher assessment rate wouldn’t need to take effect until the DIF meets its previous minimum reserve ratio of 1.15%, which the FDIC expects will happen sometime in 2018. Our estimated financial impact does not consider this eventual rate hike, but based on the DIF’s current size, the total funding gap would amount to roughly $14 billion that the FDIC would ask the largest banks to make up, said S&P.
S&P has also expanded its range of what the Volcker Rule, a section of the DFA that prevents an institution that owns a bank from engaging in proprietary trading not requested by its clients, and from owning or investing in a hedge fund or private equity fund, as well as limiting the liabilities that the largest banks could hold, could cost U.S. banks to $2 billion to $10 billion from an original estimate of $3.5 billion to $4 billion because it believes the final rule, depending on how it’s written, could have a wide impact on bank revenues.
S&P expects the DFA will weigh heavily on bottom lines. We continue to expect U.S. banks will face incremental costs to meet new reporting and compliance requirements under the DFA. Expenses will likely relate to technology upgrades and new hiring. We assumed expenses will rise by roughly 0.5% of 2011 revenues. Although this is a relatively small amount, it comes on top of any costs already in place as banks comply with new or expected rules.
(JDC)