A few regulatory highlights from yesterday's Q1 earnings calls
Also: living wills, Governor Bowman on de novo bank chartering, and an approval letter from the Fed on UBS-Credit Suisse
Bank earnings season kicked off in earnest Friday morning with announcements from JPMorgan Chase, Citigroup, Wells Fargo and PNC. From a financial perspective, things looked pretty good. From a bank regulatory perspective, highlights included the following.
JPM on capital
Consistent with last quarter, the most entertaining discussion of regulatory capital came from Jamie Dimon and Jeremy Barnum at JPM. For instance:
JPM is for planning purposes assuming an unchanged stress capital buffer but, per Barnum, “contrary to what I've heard some people argue, our ability to predict the SCB ahead of time from running our own process is actually quite limited.”
On the forthcoming Basel endgame, Barnum remarked that last year JPM was “a little bit more optimistic that it might be … closer to capital neutral” but now “feels like it's likely to be worse than that.”
Dimon followed up on Barnum’s comments by declaring that, looking at the banking system today, “no bank should keep a loan if possible, that’s how much capital is now being required for loans.”
Dimon later continued, “If you believe it's a good thing for the system, raise the capital, more credit will go out of the system. That's fine. If that's what they want, that's fine. But they should do it with a forethought, not accidentally.”1
Things are not all bad, though. According to Dimon, JPM now has “got our smartest people figur[ing] out every angle to reduce capital requirements for JPMorgan.”2
PNC sees some sort of TLAC requirement as a certainty
In a presentation released alongside its earnings announcement PNC included a slide on where they see regulatory requirements going.
On the earnings call, management was even more direct about this, with CEO Bill Demchak saying in response to a question about anticipated regulatory changes that “TLAC, I think, is a certainty at this point.” The question now is, “how much it will be and whether it's varied as a function of size and complexity a bank.”
At the end of this back and forth, which also included a brief discussion of potential changes to the AOCI opt-out, Demchak expressed what I think is pretty understandable frustration at how we got here and how the banks that failed managed to find themselves in the position they did.
By the way, the issue, it's just -- it's worth mentioning basic interest rate risk management and the test around liquidity that banks go through, I mean, we did this, we run this stuff every single day with all sorts of different scenarios and the regulators require us to and we get measured on it [indiscernible]. I don't even know who was looking at these other banks. It's -- so to come in and say we ought to do more. We're already doing it is, I guess, my point.
Wells Fargo warns analysts to be careful about what they read; offers alternative recommendations for reading material
Thursday afternoon there was a kind of weird New York Post story sourced to a “federal official” saying that the OCC on Friday intended to discuss with Wells Fargo certain MRAs “focused on concerns of lackluster internal financial controls and a lack of oversight of stock and bond traders, according to the source.” This same source - again, purportedly a federal official - told the Post that “Wells Fargo is the problem child of the banking family . . . And they’re misbehaving yet again.”
The story also, again sort of oddly, implies that these MRAs are new and that they “were in part motivated by the bank failures earlier this month.”
On the earnings call a couple of analysts asked questions that effectively amounted to, “We know you can’t comment on MRAs or on the NY Post story … but do you have any comment?”
CEO Charlie Scharf responded to one of these questions by saying:
I would just be really careful to take the source that you're taking and using that to expand into anything beyond from whence it came. If it was anything meaningful to report, we report it.
For those looking for alternative reading material, during the earnings call Scharf referred a few times to the letter he included in Wells Fargo’s annual report which discusses the company’s regulatory progress in more detail.
Listen, I would refer you back to my shareholder letter where I wrote about it extensively. And I think we still continue to feel exactly the way we felt when we wrote that letter. It wasn't that long ago, which is we have continued work to do.
You can read that letter here - it is around a month old by now, but I admit I totally missed it until yesterday.
The letter is interesting for, among other things, Scharf’s response to Acting Comptroller Hsu’s suggestion that some banks might be too big manage. Scharf’s take? Maybe some are (he could not possibly comment), but he is pretty darn sure Wells Fargo is not.
I am not in a position to agree or disagree with this premise, but I am in a position to have the strong point of view that Wells Fargo is not too big or complex to manage. Our shortcomings are not structural, but they are the result of historically ineffective management and the lack of proper prioritization of building out an appropriate risk and control environment that will ultimately take multiple years to correct.
This portion of the letter also includes a comparison that I am guessing may have been drafted before early March.
We are large but are far less complex than many with whom we compete. In fact, we have more similarities with regional banks than other global systemically important banks (GSIBs), and strong and effective risk management processes should scale to a company of our size.
How useful are living wills?
Earlier this week FDIC Vice Chairman Travis Hill delivered his first public speech in his current role. The Vice Chairman’s remarks on SVB and S. 2155 got the big headlines, but there may also one day be implications from something a little earlier in the speech.
On the subject of resolution planning, Vice Chairman Hill noted some things currently required by the resolution rules that seem to him like a good idea and thus worthy of further attention going forward.
The SVB failure also reinforces the importance of a bank’s capability to quickly populate a data room so that potential bidders can perform due diligence. One obstacle to a quick sale of SVB was the time it took to meaningfully stand up such a platform. The FDIC’s 2021 policy statement related to IDI resolution planning and subsequent FAQs discussed the data room concept, and capabilities testing around this seems a worthwhile area of focus going forward.
At the same time, Vice Chairman Hill voiced uncertainty as to whether every aspect of resolution planning is necessarily serving much of a purpose.
I tend to be skeptical of requiring, as part of resolution planning, detailed descriptions of hypothetical failure scenarios that are extremely unlikely to happen and extensive proposals for how the bank will be resolved. How a regional bank is ultimately resolved and sold will be determined not by the failed bank during peacetime but by the FDIC and prospective acquirers during resolution, and I suspect there are better ways to explore issues that might arise in different resolution scenarios than through detailed, formal plans.
As a GOP appointee to the FDIC board of directors, Vice Chairman Hill’s views are probably unlikely to gain immediate purchase with the majority of current U.S. financial regulators. Even so, I thought his comments were interesting to re-read in light of a column from Laura Noonan at the Financial Times later in the week quoting various bankers wondering what exactly it is that everyone is doing here.
Given many executives believe the wider environment would have to be extremely fragile for a really major bank to fail, the decision by Swiss regulators has merely confirmed a long-held belief that such resolution plans are merely an academic exercise not worthy of much effort. […]
A resolution expert at one large UK bank told the Financial Times that the group is currently spending tens of millions of pounds on small army of consultants to help craft a resolution plan that might never be read, let alone called upon in a crisis. […]
“We produce hundreds and hundreds of pages of the stuff,” says the head of one large UK bank. “Of course you’re not going to follow it, it’s an entirely theoretical exercise. Still, as a framework I don’t think it’s terrible.”
To be clear, Noonan herself does not hold these views (“long live living wills” she concludes), nor does everyone she spoke with.
“Resolution planning helps make banks resolvable even if the plans are not followed to the letter when an actual resolution situation happens,” said Nicolas Véron of the Bruegel Institute.
It is a view echoed by regulators. “Even if we never use a resolution plan, the fact that it is there as the default . . . can have a positive impact on the willingness of parties to come to another solution,” one told the FT. […]
The work both creates options if a crisis does strike and allows banks to accumulate knowledge along the way, forcing management to confront potential risks and contemplate the unthinkable.
None of this debate is new exactly — see this Matt Levine column from 2016 highlighting the absurdity but also the potential utility of the exercise — but in light of recent events I think it is a good debate to have again. Particularly given that both SVB (the bank at least, if not the holding company) and Credit Suisse had resolution plans on file. How helpful were they?
Governor Bowman talks de novo chartering
On Friday Federal Reserve Board Governor Michelle Bowman visited the Wharton Financial Regulation Conference to deliver a detailed speech on her “views on de novo bank formation, or really the lack thereof.”
At a high level the speech expresses concern about the decline of the number of banks in the U.S. banking system, explains why Governor Bowman believes that “there is an unmet demand for de novo bank charters,” and offers suggestions for how impediments to de novo charters could be reduced.
Charter strip acquisitions
One potential sign of unmet demand for de novo charters is what Governor Bowman calls “charter strip acquisitions” - i.e., acquisitions in which a company seeking to start a bank with a new business model acquires a (typically small) existing bank, rather than going through the de novo chartering process.
What is the appeal of a charter strip? Simply put, it is often easier than chartering a new bank by side-stepping the de novo formation process. When evaluating a bank acquisition, regulators often rely on the legacy bank's management performance and the existing supervisory and compliance record. The purchase of an existing charter can also bring efficiencies in terms of avoiding the restrictions that apply to de novo banks, which include higher capital requirements and business model limitations for the first several years of the new bank's operation. Another benefit to a bank purchase over de novo, is that operating banks have existing core systems and other third-party relationships that can speed up the time to market for a new bank model. Therefore, a charter strip of a healthy target bank often results in a faster and cheaper approval than a de novo application.
I have a few nitpicks about whether some of the differences Governor Bowman cites here are indeed that stark in every case3 but as a general matter Governor Bowman is certainly right to identify this as a trend. For instance, as previously discussed, this year in Illinois alone two such acquisitions by crypto(ish) companies have been announced.
Governor Bowman made clear in her speech that she is not necessarily calling for regulators to make entry into the banking system through acquisition more difficult; instead, she believes the de novo process should be made more accommodative in order to put it on more equal footing with the acquisition option.
I have no objection to that in principle, but one thing I wonder about is Governor Bowman’s comment that charter strip transactions “can have an adverse effect on local banking markets.”
The target institutions for charter strips are often the smallest banks. Acquired banks may provide services in small towns or rural communities, areas that may lack robust competition. Even when these legacy bank businesses continue to operate as an add-on to the new charter-strip business model, the institution as a whole tends to become riskier, jeopardizing the long-term viability of the legacy banking business and its ability to continue providing services to the local community.
I have confessed before to being overly concerned about process sometimes, and so am open to hearing that this does not actually matter much. But if it is really true that these sorts of acquisitions have the potential to be detrimental to convenience and needs, and if the institution as a whole really does become riskier such that its long-term legacy banking business could be put in jeopardy, does it make sense that all of the recent acquisitions of this kind that required Federal Reserve Board approval have been allowed by the Board to proceed under delegated authority?4 If these are concerns that Governor Bowman or any other governor believes deserve more Board attention, there is a straightforward way to accomplish that.
Not a light-touch approach?
Elsewhere in the speech, Governor Bowman called for regulation of de novo banks to be proportional to their risks, similar to the “risk-based approaches we use throughout supervision.” The proportional approach Governor Bowman has in mind is one that “is certainly not a ‘light-touch’ approach, but rather seeks to strike an appropriate balance based on the size, activities, business model, and risks of an institution.”
Maybe this was unintentional and I am reading too much into it, but I wonder if this was meant as a subtle response to Federal Reserve Board Vice Chair for Supervision Barr, who in a Q&A back in early March said that “we tend to have a very, I would say, light-touch approach to the smaller institutions” and suggested that this light touch approach may have resulted in some risks being missed.
Ways to encourage more de novos
Governor Bowman wrapped up by offering various suggestions on how the de novo process could be made more efficient by removing certain impediments. I’ll focus on two here.
First, Governor Bowman questions whether “requiring an up-front capitalization of a de novo institution in an amount far in excess of standard capital requirements is necessary.” She wonders whether instead “a phased approach that takes into account the early performance of the de novo bank may provide similar risk protection with a lower capital burden.”
Notably, a footnote in the speech cites favorably to Rep. Andy Barr’s bill that would:
Require the federal banking agencies to phase in any capital requirements for de novos over three years
Provide a defined process for making business plan change requests that would require such requests to be acted on within 30 days of receipt. (And, if the request is denied, to explain to the bank the reasons why and suggest changes that, if made, would lead to the request being approved.)
Permit “rural community banks” to comply with a lower Community Bank Leverage Ratio of 8% for the first three years of their operations and, moreover, to phase in that 8% ratio by setting it lower in the first two years of the bank’s operations.
Second, Governor Bowman believes that lessons could be learned from the approach taken in the United Kingdom through the New Bank Start-Up Unit adopted by the PRA and FCA. Overall I think a lot of what the UK does (at least as described by Governor Bowman) makes sense, but there is one part of this that I am not sure would work out the way de novos might hope. Governor Bowman says:
Finally, the resources provided by the New Bank Start-up Unit emphasize the need for de novo institutions to contemplate and prepare for recovery, resolvability, and a solvent wind-down of operations. De novo banks often experience rapid growth, poor initial profitability, and loan quality issues that take time to emerge as the bank's portfolio matures. These factors can make de novo banks riskier than established banking franchises. The solution to potential weaknesses in de novo banks need not focus exclusively on increasing regulatory and supervisory requirements, particularly if there are lower cost alternatives like improved transparency, and better preparation for resolvability and solvent wind-down.
I worry that it is more likely that this in the United States would be seized upon as something to layer on top of the existing process, rather than as a replacement for certain existing requirements.
And even if, say, capital requirements were made a bit less demanding in exchange for de novo banks submitting wind-down plans as part of the chartering process, given the current agency process for reviewing such plans (admittedly from much larger banks), are we confident this would make the process quicker?
Federal Reserve Board approves UBS’s acquisition of U.S. subsidiaries of Credit Suisse
The Federal Reserve Board via a letter released on Friday approved UBS’s acquisition of Credit Suisse Holdings (USA), Inc. The approval itself is not surprising, but still I thought there were a couple of things in the letter worth briefly discussing.
Financial stability analysis
Section 163(b) of the Dodd-Frank Act requires prior Federal Reserve Board approval before certain very large bank holding companies may acquire any voting shares of a company that both (1) has assets of at least $10 billion and (2) is engaged in nonbanking activities described under Section 4(k) of the Bank Holding Company Act.
Setting Section 163(b) aside, the general rule is that these sorts of acquisitions of nonbanking firms using Section 4(k) authority,5 unlike acquisitions of a bank, can generally be completed by financial holding companies without prior Federal Reserve Board approval. The goal of this section of the Dodd-Frank Act, then, was to subject certain nonbanking acquisitions to the Board’s prior review.
When evaluating an application under Section 163(b) the Board is required to consider the effects of the acquisition on financial stability. Specifically, Section 163(b)(4) requires the Board to evaluate “the extent to which the proposed acquisition would result in greater or more concentrated risks to global or United States financial stability or the United States economy.” This is similar, although not identical, to the financial stability standards the Board must consider under the BHC Act.6
With that statutory framework in mind, here is how the Board’s letter analyzes the financial stability implications of the merger of the U.S. operations of two G-SIBs:
In connection with the notice under section 163(b), the Board has considered (1) whether the proposal can reasonably be expected to produce benefits to the public that outweigh possible adverse effects and (2) the extent to which the proposed acquisition would result in greater or more concentrated risks to global or U.S. financial stability or the U.S. economy.
Based on all the facts of record, the Board has determined that UBS’s request under section 163(b) should be, and hereby is, approved.
I feel a little bad for being snarky here.
For one thing, to be fair to the Board, this is not a new approach for letters of this kind. See this approval under Section 163(b) from last March, for example, which included identically brief analysis.
I also have no reason to doubt the bottom line conclusion — it seems perfectly reasonable to conclude that allowing UBS to acquire Credit Suisse’s U.S. operations is indeed enhancing (or at least not harmful) to financial stability, particularly compared to the other alternatives on the table.
But even so, in the interest of guidance to banks and the public going forward, I grumpily wonder whether it would have been helpful to hear a little more from the Board as to how it thinks about financial stability in this context.
Two IHCs
The general rule is that foreign banks with significant non-branch operations in the United States are required to organize themselves such that all those non-branch U.S. operations are held under a single intermediate holding company.
The rules also say that a foreign bank may request an exception to this rule to permit it to hold its U.S. operations through an alternative structure (for example, splitting the U.S. operations between two intermediate holding companies). Not many foreign banks have successfully sought this relief, although Deutsche Bank was able to secure approval to hold its U.S. asset management business under a second U.S. IHC.
In this case, the Board has determined that it will permit UBS for a period of one year after its acquisition of Credit Suisse’s U.S. subsidiaries to continue to hold those subsidiaries under a separate IHC, rather than immediately moving them under UBS’s existing U.S. IHC.
Regulation YY includes rules intended to prevent a foreign bank’s splitting of U.S. operations between multiple U.S. IHCs, if approved, from resulting in looser regulations applying to the foreign bank’s U.S. operations than would otherwise be the case. The concern is that, for certain regulations that apply to IHCs based on size or other risk-based factors, looking at each IHC, standing alone, would understate the degree of risk. So the rules require companies with multiple IHCs to have each IHC determine its regulatory category “as though [it and the other IHC] were a consolidated company.”
Applying that principle here, the Board’s order requires that:
Until UBS owns all of its U.S. subsidiaries through only one U.S. intermediate holding company:
a. UBS will cause CSHUSA to continue to comply with the enhanced prudential standards in the Board’s Regulations WW and YY and the reporting requirements to which CSHUSA currently is subject as a “category III U.S. intermediate holding company.”
b. UBS will treat both UBS Americas and CSHUSA each as a separate “U.S. intermediate holding company” of UBS for purposes of subpart O of Regulation YY.
This means, for example, that the U.S. operations of Credit Suisse and UBS will continue to participate separately in the Board’s supervisory stress test.
Implementation plan, but not a revised resolution plan?
The Board’s order also requires UBS to prepare an implementation plan for the new structure of the combined UBS-CS U.S. operations, including plans to comply with Category II standards that will eventually apply to the post-closing U.S. operations.
This requirement to have an implementation plan for complying with heightened post-merger requirements is similar to the conditions the Board has imposed in connection with other recent merger approval orders, such as those involving acquisitions by U.S. Bancorp and BMO Financial.
In addition to requiring implementation plans, those prior Board orders also required each acquirer to, within six months of closing, submit to the Board and FDIC an “interim update to its resolution plan.” Here, however, at least on the face of the order,7 an interim resolution plan update is not being required.
As with the abbreviated financial stability analysis discussed above, one can come up with reasonable justifications for why the Board here took the approach it did.8 Still, out of curiosity if not anything else, I would have been interested in at least a brief discussion explaining the differences in approach.
FSOC nonbank SIFI designation process proposal coming soon?
According to a notice released yesterday afternoon, next Friday the Financial Stability Oversight Council will hold a meeting at which it will discuss, in both executive and public sessions, “the Council’s proposed analytic framework for financial stability risk identification, assessment, and response, and the Council’s proposed guidance on nonbank financial company designations.”
More to come on that next week, but for now I’ll just pitch again a post I wrote last November guessing at what Treasury might be seeking to change. We’ll see how well it holds up.
Apologies for the longer-than-typical interval between posts. Normal service should resume shortly, but in the meantime thoughts, challenges, or criticisms are always welcome at bankregblog@gmail.com. As always, thanks for reading!
Although slightly less combative about it, Citigroup CEO Jane Fraser offered a take along similar lines on Citi’s earnings call later in the day: “I, amongst others, fear that more activity getting driven into [the shadow banking system], if the banking capital requirements increase, will be through the detriment of system strength and stability. So we hope that this approach will be thoughtful and targeted to where the issues actually were.”
Full context of this exchange:
Glenn Schorr: Interesting. Just a follow-up. The other thing that caught my eye in the letter is you mentioned that you're exploring new capital optimization strategies, including partnerships and securitizations. What's different than what you've already been doing for the last 30 years?
James Dimon: We've got our smartest people figure out every angle to reduce capital requirements for JPMorgan. That's the difference. And we've been doing it, but there are securitizations, there are partnerships. You've seen a lot of the private equity do the life insurance companies. And I expect that we're going to come up with a whole bunch of different things over time. And we'll shed certain assets, too.
For example, it is not unusual for the OCC or other regulators as a condition to approving the acquisition of an existing bank by a company with a new business model to seek to impose business plan restrictions similar to those imposed on de novos.
Some transactions have involved acquisitions by founders in their personal capacities, and so have not required a holding company approval, but of those that did require a Section 3 application, I believe my description of all of these as having been approved under delegated authority in recent times is correct. As always, I would appreciate being reminded of counterexamples.
Credit Suisse has a branch in the United States but does not have a U.S.-chartered bank under its U.S. intermediate holding company, so UBS’s acquisition of Credit Suisse’s non-branch U.S. operations does not involve the acquisition of a bank under Section 3 of the BHC Act.
Section 3 of the BHC Act requires the Board to “take into consideration the extent to which a proposed acquisition, merger, or consolidation would result in greater or more concentrated risks to the stability of the United States banking or financial system.” Section 4 of the BHC Act requires the Board to consider “risk to the stability of the United States banking or financial system.”
Despite the difference in language between Section 163(b)(4) and the BHC Act, to my knowledge the Board has not articulated any differences in the frameworks for evaluating transactions under the 163(b) financial stability standard vs. the BHC Act financial stability standards. See for example this 2020 order approving a transaction under both Section 163(b) and Section 4 of the BHC Act.
As always, there is the possibility that this commitment was made by UBS but not reflected in the public order, which includes the usual boilerplate about the Board having “relied on all the information, representations, and commitments that UBS provided to the Board related to the request.”
Off the top of my head two potential reasons could include:
The Board’s resolution plan rule requires a foreign bank to describe its plans for resolving its U.S. operations, and a key theme of this order is that UBS does not know precisely how those operations will look post-CS acquisition, so asking them to update their U.S. resolution plan is premature.
CS is already in the process of undertaking significant U.S. resolution plan remediation work, and the Board has concluded that CS focusing on that work is a better use of resources than requiring CS to assist with an interim update to a UBS plan that may soon be outdated.
There is also another possibility, which I doubt the Board would agree with or ever publicly embrace but is worth at least mentioning: if UBS’s own home country regulator thinks the rules for resolving GSIBs don’t work and that following them “would have triggered an international financial crisis,” how useful is a U.S. resolution plan for a Swiss bank going to be?