'Relief rally' for US bank stocks as new rules unveiled

US BANK stocks enjoyed a relief rally as uncertainty surrounding the new shape of the financial sector came to a close in the early hours of yesterday morning.

The Wall Street reform is tougher than that which was proposed a year ago by the US Treasury, helped by political winds blowing in favour of getting tough on the banks.

But the two provisions that bore the brunt of the industry’s lobbying efforts – the Volcker Rule to curb proprietary trading, and a plan to force banks to spin off swaps desks – were softened last night to secure the votes of moderate Democrats and Republicans.

Banking executives and investors reacted positively to the agreement on financial regulation, saying it was better than expected.

“We are all breathing a sigh of relief here,” a Wall Street banker said. “It could have been much worse and, on balance, we can live with this.”

The shares of most large US banks were higher in midday trading in New York, with JPMorgan Chase, Citigroup, Goldman Sachs and Morgan Stanley leading the way.

Howard Chen, an analyst at Credit Suisse, said bank stocks were enjoying a “relief rally”, as investors bet the historic overhaul in financial rules would not have a significant impact on the industry’s structure and profitability.

Wall Street banks, which lobbied furiously to dilute the most radical proposals, were surprised to see the last-minute introduction of a $19 billion (€15.4 billion) levy to cover the cost of the reforms.

However, they were adamant that it was a relatively small price to pay for a more lenient bill.

Betsy Graseck, an analyst at Morgan Stanley, estimated that the new rules would enable banks such as JPMorgan, Citi and Bank of America to retain at least 70 per cent of their derivatives business. The rest – including the controversial credit default swaps – would have to be spun off into a separately capitalised subsidiary.

“It is positive for bank stocks,” Ms Graseck wrote in a note to clients.

“The market was discounting that most of derivatives would be pushed out to a non-bank subsidiary which would have been negative for credit creation.”

Analysts said the revised Volcker rule allowing banks to invest up to 3 per cent of their tier one capital into in-house hedge funds and private equity groups would not have a dramatic effect on the capital allocation of most banks.

The only possible exception was Goldman, they argued, given its large proprietary investments in such funds.

For smaller retail banks – which have already begun to pay the price of the stricter oversight in the form of lower credit card and overdraft fees – the legislation would cap fees that debit card-issuing banks collect from merchants.

Another provision would require mortgage lenders for the first time to verify borrower income, job status and credit history to ensure loan repayment, as well as ban predatory lending practices, including eliminating payments to brokers who funnel borrowers to more expensive mortgages. – (Copyright The Financial Times Limited 2010)