Regulatory rollbacks could threaten banks' debt ratings: Fitch

A debt ratings agency said it will monitor regional banks for potential downgrades as a result of the rollback of two major regulations.

Despite improvements in bank profitability during the fourth quarter, the lighter touch from banking regulators could threaten the debt ratings of banks with between $100 billion and $250 billion of assets, Fitch Ratings said in a Monday news release. The ratings agency said that rollbacks of stress-test comparisons and liquidity coverage ratio requirements for this class banks should be a concern to investors.

“As regulatory rules are further relaxed, bifurcation of regulatory relief between Global Systemically Important Banks and smaller peers will grow,” Christopher Wolfe, analytical head for North American banks, said in the release. “All else equal, Fitch views these regulatory changes as negative for U.S. large regional banks, specifically the loss of both the annual public stress test comparability and the LCR requirement.”

Andrew Harrer/Bloomberg

Fitch will not immediately lower debt ratings for regional banks as a direct result of these regulatory rollbacks, Wolfe said.

“Instead, Fitch will assess individual bank response to these changes when they take effect,” Wolfe said.

Fitch Ratings did not identify specific banks in the news release. Calls and emails to Fitch were not immediately returned.

The Federal Reserve has issued a proposal to differentiate rules for banks holding between $100 billion and $250 billion of assets, and banks with more than $250 billion of assets. Though Congress approved regulatory relief for regional banks when it passed the Economic Growth, Regulatory Relief, and Consumer Protection Act this past spring, it is up to the Fed to write the specific rules.

Under the proposed plan, regional banks in this asset range would move from a yearly stress test to a biannual stress test, according to the Fed’s proposal. It would also remove the LCR requirement for banks with between $100 billion and $250 billion of assets, and some industry analysts have said the rollback would remove an important protection to ensure that this asset class of banks has enough liquid assets to meet cash demands under stressed conditions.

Banks in this size range include the $216 billion-asset BB&T in Winston-Salem, N.C.; the $206 billion-asset SunTrust Banks in Atlanta; and the $137 billion-asset KeyCorp in Cleveland.

An analyst at another bond rating agency, Rita Sahu at Moody’s Investors Service, recently said that these banks may see their compliance costs reduced, but they may become less attractive investments due to a higher risk of failure.

“These regulatory requirements … are kind of guardrails to ensure the safety and soundness of the institution, as well as the whole system,” Sahu said. “And so without the guardrails, it’s kind of up to management on how they want to manage their business and their balance sheet.”

In its Monday release, Fitch also noted as a potential warning signs for banks that expansion of net interest margins appears to have slowed as a result of higher deposit costs. Most large banks delayed for months raising rates on savings accounts and certificates of deposits, even as the Federal Reserve has raised rates. That created a wider spread between what banks paid depositors and the rates they charged borrowers. But large banks have recently begun paying higher deposit rates.

Additionally, commercial and industrial lending growth slowed in the third quarter, Fitch noted. Banks have been struggling with spotty C&I loan demand this year, despite the federal income tax cut.

Fitch cited several positive signs for the banking sector, including higher returns on equity, low credit costs and improved capital ratios.

Also, Fitch noted that banks’ expenses have increased, largely because of higher spending on technology, “but most banks continue to report positive operating leverage.”

A bank is considered to have positive operating leverage if its revenue is growing faster than expenses.