Basel Capital Rules Likely to Favor Smaller US Banks

Reuters posted a short piece last week related to expected advantages that the recently proposed capital rules for the largest banking institutions will provide to the next largest tier of US banking companies.

Under the new Basel III guidelines, the very largest banks may need to retain as much as 2.5% more in capital to support their unwelcome status as what is commonly known as Systematically Important Financial Institutions (“SIFI”).  Should these rules become final, we would agree that the largest US banks (JP Morgan, Citigroup and Bank of America) and their shareholders may become very envious of that next largest tier of US banks including, US Bancorp, Wells Fargo and PNC.

That’s because it is very likely that these smaller institutions, with their lower capital requirements will have a relatively lower cost of capital which should translate into better operating margins and more profits.  The knock-on effect could very well be higher dividends and better yields for their stockholders.

We’re not sure that the average “sophisticated investor” will really be making any distinction between the credit worthiness of a Citigroup versus a Wells Fargo under anything  close to normalized market conditions.  They will, however, certainly take note of better price performance and higher dividends.

As one industry expert predicted, one of the net results will undoubtedly be an artificially high reluctance for bankers to make loans, even good loans, which runs totally against the grain of  “banker DNA”.

The potential impact on the securitization industry, as if there weren’t enough other new regulations for this market to worry about, is that the transaction costs for abs, mbs and cmbs financings, for the traditionally most active market participants, become even less attractive to those issuers.

Yet another example of where the cure may be worse than the disease.  Down the road, we can envision firms like US Bancorp and PNC doing everything in their power to avoid the “SIFI” designation.  Developing a strategy driven by “success but only to a certain point” does seem a little counterintuitive to us.