Fitch puts Australian banks on negative watch

From Business Insider.

Fitch Ratings has revised its outlook on Australia’s banking for 2017 to negative from stable.

In its 2017 outlook report, the agency says the change reflects an increase in macroeconomic risks and pressure on profit growth.

The change follows Moody’s which in August last year changed the outlook for the banking system in Australia to negative from stable.

Profits at Australia’s banks are under pressure. The combined cash profits of the big four banks didn’t make last year’s record $30 billion.

Fitch now says Australia’s household debt is high and rising relative to disposable incomes, making borrowers sensitive to changes in the labour market and interest rates.

“Profit growth is likely to continue to slow in 2017, reflecting low interest rates, slow asset growth, competition for assets and deposits, higher funding costs, and a rise in loan-impairment charges,” Fitch says.

Fitch expects improvements in cost management to be offset by increased investment in technology.

The agency says the ongoing rise in household debt and house-price growth heightens the banking system’s sensitivities to a sharp correction if labour market conditions and interest rates changed.

“In addition, a worse-than-expected slowdown in China’s growth would negatively impact Australia’s economy given the countries’ strong economic ties,” the agency says.

“These scenarios — although not our base case — could jeopardise the banks’ strong asset quality and profitability, and weaken capitalisation.

“A prolonged global funding market disruption could place significant pressure on the banks’ balance sheets despite the improvements in liquidity.”

Standard and Poor’s in July last last year placed Australia’s sovereign rating on credit watch negative from its previously stable outlook.

EU Covered Bond Liquidity Buffer Could Be Rating Positive

Fitch Ratings says the introduction of liquidity buffers as recommended by the European Banking Authority (EBA) could in some cases increase the difference between the Issuer Default Rating (IDR) and covered bond rating determined by Fitch.

The potential for rating upgrades would apply to legislative covered bonds secured by standard assets such as mortgages and public sector exposures issued in jurisdictions with no mandatory liquidity protection such as Austria, Slovakia and Spain.

The proposed liquidity buffer forms part of step one of the EBA’s three-step recommendations on harmonisation of covered bonds frameworks in the European Union, published in December. Step one aims to provide a definition of covered bonds for regulatory recognition.

While many covered bonds include liquidity protection, requiring it as a basic feature would mark a departure from the historical concept of this type of secured bank debt. Without liquidity buffers, investor protection primarily rests on the prospect of higher recoveries from the segregated cover pool if an issuer defaults. Adding liquidity protection may also lower the probability of default on a covered bond relative to that of the issuing institution. This would depend on the length of the protection, and whether alternative refinancing can be found during this time at a cost which can be met through over-collateralisation.

The EBA proposes a buffer of liquid assets covering net outflows between cover assets and covered bonds at least over the next 180 days following an issuer default. It does not distinguish between interest and principal payments. The same timeframe would apply irrespective of the cover asset type. The proposed minimum protection of 180 days is less than the market standard for mortgage programmes, which is a 12-month extension. Fitch does not expect legislation or programmes with longer liquidity protection mechanisms to revert to the proposed minimum, and as a result we do not expect negative rating impact.

Unlike the EBA recommendation, Fitch differentiates between interest and principal payment interruption risk. For interest payments, Fitch expects at least three-month coverage on a rolling basis plus a buffer for senior expenses to assign rating uplifts for payment continuity of four or more notches. Fitch generally expects this protection to be provided on a gross basis, ie disregarding scheduled incoming cash flows. This is to mitigate disruption stemming from operational hurdles such as redirecting cash flows or setting up alternative management after an issuer default.

Regarding principal payments, the recommended six-month protection would be eligible for a maximum five notch payment continuity uplift if the cover pool consists of public sector exposure in developed banking markets, and a lower uplift of three or four notches if the cover pool consists of residential or commercial real estate mortgage loans in developed banking markets. A six-month protection is unlikely to lead to any payment continuity uplift for programmes secured by ship mortgages or aircraft financing, as Fitch views these asset classes as too illiquid, and a limited number of programmes offer an alternative refinancing option.

The EBA’s recommended definition of liquid assets is slightly wider than Fitch’s, in particular regarding LCR Level2A assets. In our programme analysis, we take the respective definition of liquid assets into account and may reduce payment continuity uplift if the discrepancy to our criteria is material. However, we expect this to be the case for a limited number of programmes, as we generally see liquid assets defined as cash in combination with an account bank replacement provision.

Fitch says Australia’s public debt likely to peak later – and higher

Australia’s public debt ratios are likely to peak later – and at a higher level – than previously expected by the government and Fitch Ratings as the economic outlook weakens. However, the debt trajectory remains consistent with our ‘AAA’/Stable sovereign rating on Australia, most recently affirmed in September.

The government increased its budget deficit forecasts for the underlying cash balance by a cumulative AUD10.3bn (0.6% of GDP) for the next four years, largely owing to lower expectations for real GDP growth and wage inflation, according to its Mid-Year Economic and Fiscal Outlook (MYEFO), released on Monday. It also projected gross and net debt ratios would peak in FY19 (12 months to end-June), a year later than forecasted six months ago in the 2017 budget. That said, revisions were smaller than those that have been made in recent years, mainly in response to sharp falls in commodity prices.

Fitch still expects the government to reduce its deficit at a slower rate than official forecasts. The MYEFO abandons the practice of assuming commodity prices will remain at recent averages; instead, it factors in a steady decline from current levels, though using price assumptions that are still higher than our own. We also believe the government will find it hard to deliver on hitherto unlegislated spending cuts assumed in the MYEFO, worth a cumulative AUD13.2bn (0.8% of GDP) by FY20, given that the coalition government lacks a majority in the Senate. The government has made some progress on budget repair through the legislature since the July election, saving AUD6.3bn in the Omnibus Savings Bill and raising AUD4.7bn in revenues through increasing tobacco excise. However, forming a political consensus over the remaining measures will be considerably more challenging.

General government debt is now likely to peak at a level slightly higher than the 40.4% of GDP that we forecast for FY18 at the time of our September review. This would still be broadly in line with the median public debt/GDP ratio for ‘AAA’-rated sovereigns, of 42%. However, the deterioration since 2007 – when general government debt was less than 10% of GDP – has eroded the sovereign’s buffer against shocks. A housing market downturn or another slowdown in the global economy, for example, could weigh on Australia’s rating if it resulted in further significant deterioration in public finances.

Australia’s fiscal outlook is sensitive to economic performance, a risk highlighted by the -0.5% qoq fall in Australia’s GDP in 3Q16, the first contraction in five years. Some of the factors behind the decline are likely to prove temporary – public investment fell sharply after a strong second quarter, construction activity was hampered by poor weather, and coal-mine disruption held back exports. Furthermore, the drag from falling mining investment should continue to fade in coming quarters, while real exports will be boosted by LNG projects reaching the production stage. However, last quarter’s data also showed a slowdown in consumer spending growth – in keeping with subdued wage gains – and continued weakness in non-mining investment. Fitch had previously expected the economy to expand 2.9% in 2016 and 2017, but those forecasts now face a higher risk of downside adjustments

Fed Rate Increase Heralds a Step Up in Normalization

The US Federal Reserve’s decision to increase interest rates heralds a more rapid normalisation of US monetary policy in 2017 and 2018, Fitch Ratings says. A changing macroeconomic and policy backdrop means that the Fed is less likely to delay further increases, although it will still move gradually by historical standards, and its monetary stance remains loose.

The Fed’s decision to raise the target range of the Federal Funds rate by 25 bp to 0.5%-0.75% comes one year after it began normalisation at the end of 2015. Our latest forecast is for two 25 bp hikes next year but there are risks of a faster pace of increase. US core inflation is now above 2% by some measures, wage inflation has picked up over the last 18 months, and unit labour cost growth has remained steadily above 2%. Unemployment is below most measures of the natural rate and this seems to be garnering greater attention in the Fed’s thinking.

Moreover, US growth is less likely to disappoint as it did in 1H16, thanks to a pick-up in private sector investment growth, tighter labour market conditions supporting consumption, and the short-term boost from the incoming Trump administration’s planned tax cuts. The President-elect’s proposals are unlikely to be enacted in full, but Fitch assumed a fiscal stimulus of 0.5%-0.75% of GDP in our November Global Economic Outlook. This saw us revise our US real GDP growth forecasts to 2.2% in 2017 and 2.3% in 2018, up from our pre-election forecasts of 2.0% and 2.2%.

More expensive funding costs and a stronger dollar could counteract fiscal stimulus to some extent. The prospect of Fed hikes and reflationary US economic policy, combined with rising oil prices, have already pushed longer-term market rates sharply higher (10-year US treasury yields are around 2.5%, from around 1.8% in the run-up to the US election), but the still gradual Fed tightening that we forecast does not pose a risk to economic expansion. Policy rates are still low relative to growth and inflation prospects and sovereign borrowing costs remain low.

Possible triggers for faster Fed normalisation might include a bigger fiscal stimulus with a greater focus on public infrastructure than we currently anticipate and further accelerations in wage growth. In addition, the effect of fiscal stimulus on US inflation would be magnified if Trump were to follow through on promises to restrict imports from Mexico and China, but the timing and scope of any such measures are unpredictable and are not incorporated in our US GDP or interest rate forecasts.

The shifting US fiscal backdrop to the Fed decision illustrates how central banks will no longer constitute the only source of macro policy stimulus in 2017. Easier fiscal policy is one reason we expect global growth to pick up in 2017 (to 2.9%, from 2.5% this year).

But the interplay of US economic, fiscal and monetary policy may create global challenges. The prospect of US rate rises has led to periodic bouts of financial market volatility in recent years. With the ECB and BOJ still pursuing ultra-loose monetary policy, Fed normalisation is likely to extend the current period of dollar strength. This could be positive for other advanced economies but may increase the cost or reduce the availability of external funding for some emerging markets. A stronger dollar and relative EM currency weakness are reasons why EM sovereign rating pressure looks likely to continue in 2017.

Fitch On China’s Banking Sector

Fitch Ratings’ outlook for the Chinese banking sector in 2017 is negative,  as weak profitability and strong credit growth will keep capitalisation under pressure. High and rising leverage in the corporate sector remains a key risk facing China’s banks.

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China’s debt-resolution timeline is being pushed back by measures to lessen the debt burden on corporate borrowers – including low interest rates, loan rollovers, debt-for-equity swaps and a loosening of prudential controls. Leverage will continue to increase, especially at the corporate level, as long as there is reliance on credit to support GDP growth targets. We have revised up our estimates for growth in leverage, with Fitch-adjusted total social financing/GDP now likely to reach 258% by end-2016 and 274% by end-2017.

The authorities’ attempt to boost household lending may help to diversify risks. Household lending is relatively safe compared with corporate lending – given low LTV for mortgages, low household leverage and a high savings rate. However, rapid mortgage growth is driving sharp increases in residential property prices, and has the potential to fuel a further increase in corporate leverage since corporate borrowers use real estate as collateral to secure lending. Furthermore, policy guidance for banks to extend lending to struggling borrowers in over-capacity sectors also weighs on the banks’ risk-management and governance.

Fitch expects NPL and ‘special mention’ loan ratios to continue rising in 2017. Bank profitability will remain lacklustre and under pressure, owing to another likely cut in the benchmark one-year lending rate and further migration of deposits toward wealth management products (WMPs). WMPs now account for 17% of system deposits, and are a source of funding and liquidity risks for the banking sector.

Our forecast of flat profit growth and a double-digit increase in risk-weighted assets suggests that capitalisation will remain under pressure. The amount of announced AT1 and T2 issuance is not enough to keep pace with banks’ balance-sheet expansion, while equity-raising will be difficult in light of falling ROEs and questions over China’s medium-term growth.

Fitch’s previous research estimates that a one-off resolution of the debt problem would currently result in a capital shortfall of CNY7.4trn-13.6trn (USD1.1trn-2.1trn) – equivalent to around 11%-20% of GDP. The capital gap could rise further if current rates of inefficient credit are sustained and no additional capital is raised.

The Viability Ratings (VRs) of Chinese banks range from ‘bb’ to ‘b’, which reflects Fitch’s base case of varying-but-significant risks to capital and asset quality. These risks will linger unless there is a shift to a more stable operating environment, characterised by slower credit growth and higher loss-absorption buffers. Fitch’s stable rating outlook reflects our expectation of state support, which remains the sole rating driver for Chinese bank IDRs. More corporate debt is ultimately likely to migrate towards the sovereign balance sheet beyond the local government swap programme.

 

Political Risk Looms Large for Global Sovereigns in 2017

Global sovereigns face elevated levels of political risk and uncertainty in 2017, says Fitch Ratings, embodied by the unexpected election of President-elect Donald Trump in the US and the UK’s Brexit vote in June.

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These risks are reflected in a trend away from political orthodoxy that reduces the predictability of policy direction in advanced countries in 2017. Combined with a general trend towards looser fiscal policy and greater trade protectionism, this carries risks to sovereign creditworthiness among both advanced economies and emerging markets (EM), although the overall outlook for Fitch’s sovereign ratings in 2017 is stable.

While the large majority (82 of 114) of Fitch’s sovereign ratings retain Stable Outlooks as we head into 2017, risks are clearly tilted to the downside, given the distribution of 25 Negative and only three Positive Outlooks. The threat of increased trade protectionism and a stronger dollar will maintain downward pressure on EM sovereigns’ macroeconomic performance and ratings, with 20 remaining on Negative Outlook as we move towards year-end. Key EM sovereign rating sensitivities will include the extent to which policy responses can mitigate the negative effects of subdued commodity prices, weaker trade flows and the potential for renewed dollar strength.

Fitch expects global GDP growth to increase to 2.9% in 2017, from 2.5% in 2016, driven largely by a pick-up in the US combined with a cyclical recovery in some of the largest EMs, which should more than offset continuing weakness in the eurozone and Japan. Our forecast of an acceleration in 2017 US growth to 2.2%, from 1.5%, reflects partly our assessment of the impact of President-elect Trump’s proposed reflationary policies, including corporate and personal income tax cuts combined with a focus on infrastructure investment. We expect this fiscal stimulus (totalling 0.5-0.75% of GDP) to produce a near-term boost to growth, but the president-elect’s rhetoric on trade policy increases downside risks to growth in the medium term.

Following the seismic political shocks of 2016, Fitch expects political risk to remain a key issue for sovereign creditworthiness in advanced economies in 2017, posing risks to medium-term economic growth prospects that would likely be negative for sovereign ratings. Euroscepticism and populism could affect European cohesion in the coming months, with the Italian constitutional referendum in early December to be followed by Dutch, French and German national elections in 2017. Any further significant political shocks triggered by electoral events in Europe could prove hugely damaging for the European project, although such a scenario is not Fitch’s base case.

With advanced economies failing to regain pre-crisis growth rates, the debate on global macroeconomic policy has shifted, with commentators, policy-makers and supranational institutions all calling for a move towards fiscal loosening and away from the reliance on ultra-loose monetary policy that has become the cornerstone of macro policy in recent years. This shift in policy emphasis is likely to be led by the US in view of the proposed reflationary domestic policy agenda and the prospects for higher interest rates. While it is likely to provide a near-term boost to growth, the fiscal impact of the Trump plan would likely be negative for US sovereign creditworthiness over the medium term, as tax cuts alone cannot generate enough growth to make up for the loss in revenue, leading to a deterioration in debt dynamics.

In Europe, fiscal loosening is already being pursued to some extent as austerity fatigue and a focus on political issues such as Brexit, the migrant crisis and security concerns have diverted attention away from fiscal consolidation. This has manifested itself in many eurozone governments moving away from a strict interpretation of the European fiscal rules, typically without sanction by the European Commission. This is likely to be growth-supportive in the near term but further undermines fiscal credibility. High public debt ratios remain one of the key rating weaknesses for western European sovereigns, meaning that few have material fiscal space within their existing rating categories.

Economic recovery in the largest EM countries should gain momentum in 2017 as crises in Brazil and Russia ease. Meanwhile, we expect the slowdown in China’s growth rate to continue on a gradual path, reducing to 6.4% in 2017 from 6.7% in 2016. In Fitch’s view, China will remain committed to its growth target of approximately 6.5%, particularly given the political transition of five of the seven members of the Politburo Standing Committee scheduled for 2H17.

The threat of less open trade relationships between the US and key trading partners, including China, combined with a stronger dollar would be generally negative for EM countries, and particularly so for smaller open economies. A “trade war” between the US and China would have adverse consequences for GDP growth and inflation in both countries, and could lead to depreciation of the RMB and financial market risk aversion, which would likely spill over to other emerging markets.

Basel IV Proposals May Lead to EU/US Divergence

Basel Committee discussions on “Basel IV” at the end of November may expose deep divisions between national members and could lead to further differentiation between the EU and internationally agreed Basel standards, Fitch Ratings says. This would exacerbate challenges for market participants attempting to compare the capital strength of banks globally and could undermine confidence in a framework aimed at promoting a level playing field.

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The latest Basel III amendments (sometimes referred to as “Basel IV”) seek to restrict the use of internal risk models, which are associated with wide divergences in risk-weighted measures, and potentially set overall capital requirements using the revised standardised approaches. EU politicians have expressed significant concerns in their parliamentary submissions ahead of a vote on the EU’s finalisation of Basel III on 24 November. Meanwhile, regulators such as Thomas Hoenig of the US FDIC recently warned against the dilution of the reforms and support tougher equity-based requirements.

If enacted the proposals are likely to increase capital requirements for lower risk-weight portfolios, such as mortgage loans, despite the committee’s intention not to significantly raise capital requirements for banks globally. European banks generally hold larger mortgage portfolios and would be more affected. EU regulators seek to balance the economic consequence of any increase in capital requirements against the challenges banks face to boost capital internally in light of negative yields and low growth prospects. EU lawmakers say they are aiming for “global standards with local calibration”.

In contrast, US banks would be less affected as they typically sell their mortgage loans to US government agencies and larger firms already hold capital on the higher of the standardised and internal ratings-based (IRB) approaches. US supervisors also might be more willing to set higher capital standards due to the more supportive operating environment and lower reliance on loan-based finance than the EU.

These tensions are likely to be reflected in two key areas in the 28-29 November Basel discussions. The proposal for a capital floor based on a certain percentage of the standardised approaches has the greatest potential for EU divergence. Whether the committee sets an overall floor or one for each risk category is important. EU lawmakers have publicly protested that a floor would severely punish stable banks focused on traditional low-risk lending, while banks with higher-risk assets would be less affected. The impact on European mortgage banks may be a key consideration here as residential mortgage loans are potentially most vulnerable, especially if a permanent capital floor were to be applied on a risk-category basis.

We believe outright elimination of internal ratings models for certain credit exposures is unlikely. The speech by Stefan Ingves, chair of the Basel Committee on 10 November did not mention this. EU lawmakers are concerned about the impact on credit flow to the real economy and have argued that working to enhance trust in IRB models is preferable to abandoning them for portfolios such as large corporates. We believe there would be a generous transitional phase-out period even if the committee does move away from using models for these portfolios.

We think it is more likely that specific constraints will be introduced to reduce risk-weight variability, as proposed for modelling mid-sized corporate and retail exposures, and to ensure a minimum level of conservatism, for example through the introduction of specific loss given default floors in models for residential and commercial real estate exposures. But other measures, such as a model floor for unconditionally cancellable commitments, which may effectively increase capital charges for these exposures, face opposition from both sides of the Atlantic due to concerns it would constrain banks’ lending capacity.

Digitalisation Key as European Banks Adapt Business Model

Large European banks’ ability to modernise their banking platforms and improve digital services will be critical to remaining competitive in the long term, Fitch Ratings says.

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But the cost of these new systems is high and comes at a time when record low interest rates are weighing heavily on earnings and burdensome regulatory changes are eating up time and resources. Banks that take too long, or which cannot afford to invest on a continuing basis, may see their franchise fall behind.

Banks are investing to ensure their support systems are compatible with their product offerings so they can service clients’ needs as seamlessly as possible. This is part of a wider shift from product-focused to client-focused business models, which we believe perform better over time. They are also responding to smaller, digitally focused challenger banks.

These challenger banks have shown some success in retail banking niches, but we believe economies of scale should give Europe’s large banks an advantage once they have successfully updated their infrastructure. The costs of compliance, credit risk management, and regulatory systems and staff will weigh particularly heavily on challenger banks as they develop. Small retail banks, like their larger rivals, also need to invest to address the threats of digitalisation, such as cybercrime, which we see as one of the greatest risks facing banks and one of the hardest to control.

As banks plan these investments, they are also having to adapt their business models to cope with a lower-for-longer interest-rate environment and regulations that are heightening capital and liquidity needs and, in some cases, driving changes to their legal structures.

The clearest impact of low rates is in traditional retail banking, where even interest-free deposits are no longer attractive and very low interest rates on mortgage loans are hurting net interest margins. Low rates are also making it harder for Europe’s banks to generate revenue from corporate lending and fixed-income products as investment demand is very low. Wealth management operations are feeling pressure due to the disappearance of risk-free returns on client deposits and a reduction in client activity.

The ability to adapt business models to meet these challenges can be critical for ratings. Over the past year we have downgraded Credit Suisse Group and Deutsche Bank based on our view that their capital markets-focused business models have become less resilient to changes in regulation and their business environment, especially as the banks are undergoing costs of implementing turnaround strategies, in Deutsche Bank’s case including substantial IT spend.

Successful execution of the strategies introduced by new chief executives of both banks in 2015 depends on building up stronger core client franchises. For Deutsche Bank, this is primarily with European corporates, for Credit Suisse it is largely with Asian high-net-worth individuals.

Australia’s Major Banks Face More Profitability Pressure

According to Fitch Ratings, the operating profit of Australia’s four major banks is likely to come under further pressure in the next 12 months, as stress emanating from the mining and apartment-building sectors continues to undermine asset quality, says Fitch Ratings. However, Australian banks are still likely to remain highly profitable compared with their international peers, and are in a strong position to cope with capital pressures that might result from upcoming regulatory changes.

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The four major banks – Australia and New Zealand Banking Group (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank (NAB) and Westpac Banking (WBC) – posted the first drop in their combined pre-tax profit in eight years in the financial year 2016 (FY16). Pre-tax profit fell to AUD41bn (USD32bn), 7% lower than FY15. Profit was hit by a 36% increase in loan-impairment charges – albeit from a cyclical low – which reflected problems in the resources sector and its knock-on effects for businesses and households in mining areas. CBA was the only one to report pre-tax profit growth, of 2%. ANZ’s pre-tax profit dropped the most, by 22%, largely owing to restructuring costs and valuation adjustments. Further restructuring costs are likely in FY17, as ANZ says it is refocusing on the Australia and New Zealand market, and its profitable Asian institutional business. Restructuring costs also weighed on NAB’s pre-tax profit, but the sale of its UK business and partial sale of its life insurance operations are now completed and will not affect FY17 results.

Fitch expects Australia’s banks to face a weak operating environment again in FY17. Net interest margins are likely to be squeezed further by higher wholesale funding costs, and tougher loan and deposit competition. Falling mining investment and weaker employment in the resources sector will continue to weigh on the performance of banks’ mining sector exposure, despite the recovery of some commodity prices this year. Increased technology expenses and compliance costs will undermine efforts at cost management.

Property developers may also soon start experiencing problems settling agreed apartment sales, which may feed through to banks over the next 18 months. The decision by the four major banks earlier this year to stop lending to non-resident property investors means the latter are now likely to find it harder to source finance to complete agreed purchases, and may back out of deals.

Australia’s major banks are in a good position to cope with the weaker conditions, in our view, as their balance sheets are robust. All banks have issued additional common equity in the last 18 months to boost capital buffers in response to regulatory changes. Even with a drop in profitability they have the flexibility to meet increases in capital requirements that might come with the introduction of Basel IV or changes to the Australian Prudential Regulation Authority’s guidelines.

Moreover, their direct exposure to the mining and property development sectors is relatively small and manageable. Asset quality is likely to remain relatively strong in the absence of broader problems in the mortgage market, which dominates banks’ balance sheets.

High underemployment appears to be creating stress for some mortgage borrowers – arrears have risen over the last year, albeit to a still-low 1.14% of total mortgages. Moreover, high debt levels make households vulnerable to a rise in interest rates or further deterioration in the labour market. However, Fitch does not expect the Reserve Bank of Australia to start raising its cash rate until 2018, and the unemployment rate is likely to remain stable. Improvements in banks’ underwriting standards since mid-2015 should also provide a cushion, especially since the sharp increase in property prices since then has boosted the equity of earlier home buyers.

Trump Regulatory Changes May Not Be a Win for Banks

Fitch Ratings says US financial institution (FI) regulatory reform may feature as a priority legislative agenda item, reflecting the campaign of President-elect Donald Trump as well as the ongoing views of several key majority Congressional leaders.

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Fitch does not foresee any changes to US FI ratings as a result of the election. Changes that potentially reduce capital or liquidity requirements are likely to be a negative, but the impact on individual ratings will depend on how banks respond to this change. To the extent that capital or liquidity levels decline materially, that could result in negative rating implications, but Fitch views this scenario as unlikely.

The Dodd-Frank Act (DFA) has featured as a target in President-elect Donald Trump’s campaign statements, but most aspects of DFA have been implemented, and it is unclear whether a wholesale repeal could pass or what a partial repeal may encompass.

The Consumer Financial Protection Bureau is a relatively high-profile target for those opposed to the DFA, but its elimination on its own would be unlikely to have a material impact for banks in the aggregate. Notably, there has been little specific discussion of peeling back the Volcker Rule or Resolution Authority, some of the more costly aspects of the DFA. Fitch notes that the reduction in proprietary trading activity linked to Volcker has been largely positive for banks, while the resolution process has been largely positive for banks’ governance.

Anti-Wall Street sentiment has been a recurring theme in the presidential campaign for both candidates, so it remains an open question as to the likelihood or urgency of any proposed financial sector regulatory reform or repeal. Smaller regional or community banks may be viewed as more worthy beneficiaries of regulatory relief than money center banks. In addition, the reintroduction of Glass-Steagall (GS) is unlikely to be a policy priority. The reintroduction of some elements of GS was included in both parties’ platforms, but it was not a prominent theme in the campaign. The industry is likely to continue to strenuously oppose regulation that would re-impose restrictions that had existed under GS.

It is also important to note that capital and liquidity requirements have not historically been dictated by the Legislature but through banking regulators in the US. The US has adopted Basel III and those requirements will continue to be implemented, regardless of the administration. Therefore, while aspects of the DFA may be peeled back, core banking regulation is unlikely to change.

Generally, US financial institutions’ performance tends to be correlated with the overall US macroeconomic environment, particularly as it relates to economic growth. Judging by the campaign, the new administration’s economic policy is likely to revolve around tax cuts, renegotiating trade agreements, de-regulation and higher infrastructure spending. However, it remains to be seen the degree to which Trump will implement or be able to carry out his policy initiatives and the long-term effect policy changes will have on growth.

In the near term, increased policy uncertainty could dampen prospects for private investment growth. If the Fed judged these effects were likely to outweigh the impact of any additional fiscal easing, it may prompt them to raise rates at a slower pace than previously expected over the coming year. This would delay any positive operating leverage from rate hikes out further, as the impact tends to be lagged. Overall, Fitch expects that incremental interest rate increases would be positive for banks’ net interest margins.