PacWest is helping regulators make their case for bolstering US banks

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A regional lender in Beverly Hills may have helped regulators bolster the case they plan to make Thursday to shore up banks across the US.

PacWest (PACW), which had been struggling to recover from the downfall of Silicon Valley Bank in March, on Tuesday said it found a rescuer in Banc of California (BANC). The two plan to combine with $400 million in financing from private equity firms Warburg Pincus and Centerbridge.

The announcement was a fresh reminder that the turmoil that started in the spring is still not over for the banking industry, which still faces questions about its strength as lenders struggle with high interest rates, rising funding costs, and declining profitability.

PacWest stock declined 27% Tuesday and then soared 25% Wednesday morning.

The fresh volatility may come in handy for regulators as the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency try to sell a complex overhaul of new capital standards for banks on Thursday.

They argue the changes are needed to make lenders stronger, more resilient, and better prepared for shocks like the crisis of this spring, when the failures of Silicon Valley Bank, Signature Bank, and First Republic triggered deposit withdrawals across the banking world. PacWest, caught up in that panic, sold assets to bolster its liquidity and capital strength.

The new capital proposals are expected to face pushback from the banking industry, which argues that lenders are much more resilient than they were during the 2008-09 financial crisis and that higher requirements could restrict lending.

Read more: How to get a personal loan with bad credit

Federal Reserve Board of Governors Vice Chair for Supervision Michael Barr testifies before Congress.

Federal Reserve’s vice chair for supervision, Michael Barr. (Andrew Harnik/AP Photo)

Fed vice chair for supervision Michael Barr said earlier this month that the Fed would principally raise capital requirements for the largest, most complex banks. The biggest institutions will be asked to hold an additional 2 percentage points of capital — or an additional $2 of capital for every $100 of risk-weighted assets. Capital is the buffer banks have to hold to absorb future losses.

He also said regulators would widen the scope of the new rules to institutions with as few as $100 billion in assets, meaning roughly 30 banks would be subject to them. The combined PacWest and Banc of California would be under that cap, based on their combined assets of $36 billion.

‘Risk weights’

These changes are part of the US version of an international accord known as Basel III that was developed following the 2008 crisis by the Basel Committee on Banking Supervision.

The goal of that committee — which was convened by the Bank for International Settlements in Basel, Switzerland — was to set global regulatory capital standards so that banks would have enough in reserve to survive crises. The last version of this accord was agreed to in 2017, but plans to roll it out in the US were delayed by the COVID-19 pandemic.

A key component of the revised rules will be a series of so-called “risk weights” applied to various assets banks hold. The riskier the assets are, the more capital banks will be required to set aside to absorb any future losses. Those assets can range from Treasuries and mortgages to derivatives and cryptocurrencies.

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Barr has said that most banks already have enough capital to meet the new standards and estimated that banks would be able to build the required capital through retained earnings in less than two years — even while maintaining their dividends.

“These changes would increase capital requirements overall, but I want to emphasize that they would principally raise capital requirements for the largest, most complex banks,” he said in a speech earlier this month at the Bipartisan Policy Center in Washington.

He also made it clear that banks would have time to weigh in with any comments before the proposal is final. “We intend to consider comments carefully and any changes would be implemented with an appropriate phase-in,” he said, adding that most banks already have enough capital to meet the new requirements.

Betsy Graseck, an equity analyst for Morgan Stanley said she anticipates the “phase-in” for the largest banks to take three to five years.

“A later phase in would be a positive for the group as it enables additional capital accretion through earnings generation,” Graseck wrote in a Tuesday research note. “An earlier, or shorter, phase in would be a negative.”

By Graseck’s calculations, JPMorgan Chase (JPM) and Bank of America (BAC) can cover the increased capital requirements from earnings in less than two years’ time. It would take Goldman Sachs (GS) three years and Citigroup (C) four years, she said.

‘Dancing in the streets’

Banks are expected to push back.

“Further capital requirements on the largest US banks will lead to higher borrowing costs and fewer loans for consumers and businesses — slowing our economy and impacting those on the margin hardest,” Kevin Fromer, chief executive of bank lobbying group the Financial Services Forum, said on July 10.

JPMorgan Chase CEO Jamie Dimon told analysts on July 14 that nonbank lenders are already celebrating their competitive advantage.

“This is great news for hedge funds, private equity, private credit, Apollo, Blackstone,” Dimon said, naming two of the largest private equity players. “They’re dancing in the streets.” (Disclosure: Yahoo Finance is owned by Apollo Global Management.)

JPMorgan Chase CEO Jamie Dimon attends a U.S. House Financial Services Committee hearing.

JPMorgan Chase CEO Jamie Dimon. (Elizabeth Frantz/REUTERS)

Many midsize banks that could be part of these new rules are already making adjustments by holding back on any increases in dividends or share buybacks. Several also are selling assets to reduce the risks on their balance sheets or examining a pullback in certain types of lending.

Citizens Bank (CFG) has said it will stop originating auto loans. Comerica (CMA) has said it expects to exit the majority of its warehouse lending business by the end of this year.

“In a perfect world, everything that a bank is doing is profitable,” said Scott Siefers, analyst with Piper Sandler. “But if there’s now going to be a higher return requirement, meaning higher capital level, for a given asset, you might need to look more closely at your return.”

JPMorgan, the nation’s biggest bank, told analysts it might have to raise prices on certain loans.

“To the extent that we have pricing power and the higher capital requirements mean that we’re not generating the right returns for shareholders, we will try to reprice and we’ll see how that sticks,” JPMorgan CFO Jeremy Barnum said on July 14.

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