Finance

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

President Donald Trump's promises to reform health care, the U.S. tax code and infrastructure so far remain just that. Financial deregulation is moving forward, though: There's now a framework for how the regulatory burden can be lightened without rewriting the law, making the prospect of relief more concrete. 

Late Monday, the Treasury Department published a nearly 150-page report, the first of four responses to a February executive order that called for a comprehensive review of financial regulations. Its wide-ranging recommendations aren't as blunt as Congressman Jeb Hensarling's Financial Choice Act, which would authorize a full-blown rollback of post-financial-crisis regulation, and that itself makes them more likely to be considered by regulators and in some cases, the Senate. 

Relief Rally
Bank stocks have been on a bumpy ride since President Donald Trump was elected into office. They've maintained gains of roughly 25 percent, almost double the S&P 500 Index.
Source: Bloomberg

The proposal that caught my eye first is the one suggesting changes to the governance of leveraged lending. Under current guidance, banks can't facilitate borrowings for companies seeking to pile on debt at levels that regulators view as risky. This has cost them tens to hundreds of millions in lost fees and also made dealmaking more difficult for buyout firms. I've previously questioned whether bank regulators should have embarked on their pursuit to rein in this type of lending back in 2013, since their efforts certainly haven't succeeded in making the financial system safer. Instead, the issuance of these loans persisted, with less familiar faces, or unregulated or shadow lenders, leading the riskiest deals. The only difference is banks couldn't take part.

In its report, the Treasury acknowledged that borrowers have had reduced access to credit because banks were restricted from providing such loans. Its fix, which notably doesn't require any action by Congress, involves relevant regulators redefining the guidance in a way that enable banks to play a bigger role in that market again. All up, it's a key indicator that the Trump administration will at least partially succeed in meeting its pledge to loosen the shackles that have weighed on big banks and crimped lending.

For borrowers -- mostly private equity-backed companies -- it's also a positive. Potential transactions that would be been infeasible under current the guidance be may be revisited, enabling them to better dent their collective dry powder mountain.

And this case, the industry's largest players Bank of America Corp. and JPMorgan Chase & Co., which have ceded lucrative fees and market share to unregulated rivals like Leucadia National Corp.'s Jefferies Group and the capital markets arm of KKR & Co., should be able to regain some of that lost ground. 

Battlefield
The two largest leveraged lenders have had their wings clipped by regulatory guidance, which was initially loosely adhered to by rivals. Unregulated lenders, too, have taken some share.
Source: Bloomberg
*Guidance issued in March 2013

The biggest banks aren't the only beneficiaries of the report's more than 100 recommendations. Smaller banks would benefit from a proposal that would lift the threshold for being subject to regulatory stress-tests to $50 billion in total assets from its current level of $10 billion. Another? A proposal that banks with $10 billion or less in assets be exempt from the Volcker Rule's proprietary-trading prohibition.

None of the ideas in Monday's report are binding, nor is there a guarantee that they'll be implemented quickly. Federal Reserve chair Janet Yellen can refuse to heed any or all recommendations (one likely exception is leveraged lending, an area she has previously said doesn't pose a "systemic threat"). Other key posts within various agencies that may be required to sign off on any tweaks remain vacant.  

Apart from the many recommendations that can be changed purely by regulatory action, there are proposals in Monday's report that require Congressional approval. A controversial measure to curb the mandate of the Consumer Financial Protection Bureau and give Congress control of its budget, for instance, likely won't occur in 2017, if ever. 

But there are enough potential and nearer-term changes to boost bank stocks. Even apart from these, there are reasons to be enthused, including the near-certainty that the Fed will raise rates Wednesday, which should bolster interest income and improve profitability over time. And on Thursday, a Senate Banking Committee hearing focused on regional bank regulations including the too-big-to-fail threshold will provide a platform for Senate lawmakers to reveal details of their broader plans, which may incorporate some of Treasury's thinking.

Yield Swerve
This week's imminent rate hike hasn't kept traders from driving the spread between short- and long-term Treasuries to its narrowest levels since the election.
Source: Bloomberg

Plus, June 28 marks the results of the Comprehensive Capital Analysis and Review, or CCAR, which should give many of the biggest banks the green light to lift their payout ratios. Anticipation of this occurring sent the KBW Bank Index almost 5 percent higher last week alone. 

Unquestionably, bank stocks have multiple tailwinds. The strongest one, which should and will buoy their valuations, is the much-welcome clarity on deregulation and the growing belief that meaningful regulatory relief is truly within reach. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. For those that still qualify, more potential relief: Treasury is recommending the process only take place every two years rather than annually. That was one point on Jamie Dimon's wish list!

  2. Over at the Office of the Comptroller of the Currency, Trump-appointed acting chief Keith Noreika who is ironically sidelined from overseeing activities at some of the biggest banks because they were his former clients, is more likely to accept Treasury's recommendations. 

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net