Nomura Securities on Banks and Brokers: Fed Proposes New Counterparty Limits - Impact of New Counterparty Limits Likely Muted

Nomura Securities on Banks and Brokers: Fed Proposes New Counterparty Limits - Impact of New Counterparty Limits Likely Muted

Analyst, Glenn Schorr, said, "On Tuesday, the Fed released its proposed rules for “Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies” mandated under section 165 and 166 of the Dodd-Frank Act. These rules address a broad spectrum of measures such as capital, liquidity, credit exposure, stress testing, risk management and early remediation requirements – mostly memorializing what we already knew."

"Impact of 10% Credit Exposure Limit Likely Muted, but It May Curtail Large Banking Activity Depending on Regulators’ Interpretation: What caught our eye out of the 173-page proposal was the Fed proposal that “targets the mutual interconnectedness of the largest financial companies by setting a stricter 10 percent limit for credit exposure” to a single major counterparty for the largest banks. The regulators’ effort to mitigate systemic risks by limiting the interconnectedness among the big banks is consistent with the intent of the Dodd-Frank Act. Our high level analysis suggests the 10% limit would not be a big deal for the large banks when you consider counterparty netting and collateral (for example, we estimate that JPM would need $12bn of net single counterparty exposure to reach the 10% level). However, certain provisions could be interpreted in a way that would ultimately limit the size of derivatives markets and/or level the playing field for some of the smaller players. Like the Volcker proposal, the devil will be in the details."

"Credit Exposure Complexity Creates More Questions than Answers: Similar to the Volcker proposal, the complexities around counterparty credit exposures create more uncertainty around the large banking model. For example, the definition of “covered companies” and “credit exposure” are not totally clear and the Fed has listed a number of questions that it expects to receive comments on from now through March 31, 2012. In addition to comment letters from the banks, we think there could be some input from corporations concerned about the potential for higher funding costs if the new rules remove some liquidity from the market place."

"Compliance Costs Keep Rising: It is no surprise that compliance costs will continue to rise across the industry as the result of increased regulation, and the inclusion of this counterparty limitation for larger institutions just adds to the pile. Given the potential complex definition of an individual counterparty (which includes legal entity subsidiaries) and the extensive volume of transactions with larger counterparties, we anticipate cost burdens and corresponding barriers to entry would rise accordingly. The new trend on Wall Street seems to be that back offices are expanding while front offices are shrinking – it seems like the cost of doing business keeps going up."

Stocks of Note: JPMorgan (NYSE: JPM), Citi (NYSE: C), Wells Fargo (NYSE: WFC), BofA (NYSE: BAC), Morgan Stanley (NYSE: MS), Goldman Sachs (NYSE: GS), Deutsche Bank (NYSE: DB), HSBC (NYSE: HBC), MetLife (NYSE: MET), Toronto-Dominion (NYSE: TD), Prudential (NYSE: PRU), UBS (NYSE: UBS), AIG (NYSE: AIG), & RBS (NYSE: RBS)

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