Regional banks reluctantly prepare for heightened capital requirements

Regional banks are bracing for heightened regulation after the recent bank failures, much to their dismay.

During first-quarter earnings calls, regional bank executives described their expectations and efforts to prepare for federal regulatory changes related to capital requirements, including the potential for including unrealized losses in regulatory capital ratios. Many said they feel current capital rules are sufficient, and one executive said it is unfair to subject regional banks to tougher regulation after the failure of two banks with unique business models.

"I don't believe that the answer to the two bank failures is more regulation on regional banks," Citizens Financial Group Inc. Chairman and CEO Bruce Van Saun said on the company's first-quarter earnings call. "Those were idiosyncratic situations, and there was sufficient regulation. So you basically had business models that were not well diversified and the banks grew too fast and stretched management capabilities. The supervisors didn't really do their job."

Still, the executive said he expects "some tightening" around capital and liquidity rules.

Unrealized losses in capital calculations

Following the failure of Silicon Valley Bank, the Federal Reserve is considering proposing a rule requiring midsized banks to include unrealized gains and losses on available-for-sale securities in regulatory capital ratios as soon as this summer, The Wall Street Journal reported.

On first-quarter earnings calls, regional bank executives said they expect such a change, but they are unhappy about it.

"If I were king for a day, I would not change the [accumulated other comprehensive income] opt-out rules because this was not a capital crisis," Fifth Third Bancorp CFO James Leonard said on the company's first-quarter earnings call. "I think the capital regime works as stated."

PNC Financial Services Group Inc. Chairman, President and CEO William Demchak hopes regulators will take a "holistic look" at this issue, and take into account banks' current efforts to gauge interest rate risk and liquidity testing.

"We run this stuff every single day with all sorts of different scenarios and the regulators require us to and we get measured on it," he said on the company's first-quarter earnings call.

However, if regulators do make this rule change, banks said they are prepared. Fifth Third's CFO said the change would be "manageable."

Citizens Financial would also be compliant if this change were made because "we've managed our capital at the high end of our peer group," Van Saun said. "We've run very rigorous internal liquidity stress testing regimen that we'd already be in compliance with the Category III bank as well."

Bank of Hawaii Corp. will likely begin preparing for such a change soon, Chairman, President and CEO Peter Ho said on the company's first-quarter earnings call.

"We certainly have a heightened awareness around maybe the differences in [available for sale] treatment for smaller banks versus larger banks — and the prospects of smaller banks having potentially to migrate to that level," Ho said. "Where we stand on that is kind of not knowing where things stand there. We likely will begin to think through various scenarios on how we could enforce to move to that level to get there. Our preliminary view is that we would be able to do that organically over a period of time, kind of given operating assumptions that we think are reasonable at this point."

Capital conservation

With the uncertainty surrounding heightened capital requirements, many regional banks are opting to hold off on capital deployment in the near term.

"In this environment, we're going to accrete capital here in the short term," Fifth Third's Leonard said.

Similarly, Bank of Hawaii's Ho said the bank will be "pretty judicious around capital" given uncertainty about regulatory levels in the intermediate term.

The potential for heightened regulation only reinforced Popular Inc.'s conservative capital posture.

"It's anybody's guess exactly what the regulators will come up with. We do not know, but we will be attentive to how they are moving," CFO Carlos Vázquez said on the company's first-quarter earnings call. "We definitely don't want to be in a position where we do something, and there's an announcement a month later, and it makes our life much more difficult because we did something that moved us in the wrong direction."