NEW YORK (TheStreet) -- The expected finalization of the Volcker Rule this week could provide "significant opportunities for non-bank brokers and trading firms, such as Piper Jaffray (PJC) and BlackRock (BLK) and alternative managers such as KKR & Co. (KKR) and The Carlyle Group (CG)," according to KBW analyst Frederick Cannon.
The Federal Reserve, U.S. Treasury, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp. and Securities and Exchange Commission will "vote" on Tuesday on a set of finalized regulations to implement the Volcker Rule, which is part of the Dodd-Frank banking reform legislation signed into law by President Obama in July 2010.
It's not really a vote, since the regulators have had plenty of time to iron out any differences over the ban on short-term proprietary way back in October 2011.
The Volcker Rule -- named after former Federal Reserve Chairman Paul Volcker -- is meant to ban U.S. systemically important financial institutions (SIFI) from short-term "proprietary trading." The idea is that big banks enjoying the advantage of FDIC-insured deposits shouldn't be "gambling" with that money.
The big problems with implementing the Volcker Rule center on the exceptions to the ban on proprietary trading, to allow the big banks to maintain inventories of securities to fulfill their roles as market makers for their brokerage customers, and to allow some hedging activity.
The Federal Reserve in April 2012 announced that banks would need to be in full compliance with the Volcker Rule by July 2014, even though the new regulations weren't close to being completed. Even before that announcement, many of the largest banks, including JPMorgan Chase (JPM), Bank of America (BAC) and Morgan Stanley (M)S began to shut down their proprietary trading operations.
"Currently, there is more than $100 billion of trading revenue generated annually at U.S. bank holding companies, with the largest five banks [including JPMorgan, Bank of America, Morgan Stanley, Goldman Sachs (GS) and Citigroup (C)] accounting for more than 90% of that amount," Cannon wrote in a note to clients on Sunday.
In addition to the market-share opportunities for non-bank trading firms, brokers and asset managers, Cannon believes non-bank lenders will also gain as the big banks suffer. Springleaf Financial (LEAF) is one such consumer lender, according to the analyst.
It's obvious that Congress and regulators are pushing to break up the largest U.S. banks. Even though the Basel III agreement is requiring the big banks to maintain capital ratios that are at least twice as high as they were before the credit crisis, there have been rather extreme proposals by members of both parties to boost capital ratio requirements so high for large banks that the banks' own investors would have to consider spinning off units in order to become small enough to face some of the regulations.
"Put simply, the reforms we are putting in place raise the cost for a bank to be large, requiring firms to internalize their risks, and together, with resolution authority and living wills, make clear that shareholders, creditors, and executives -- not taxpayers -- will be responsible if a large financial institution fails," Treasury Secretary Jack Lew said in a speech last week.
According to Cannon, Volcker and other new rules will combine to severely curb the big banks' trading activities and "squeeze the ability of large banks to compensate employees engaged in these activities."
So there's quite a bit on the table for the large banks. Investors will be watching to see which of the "big five" named above will be first to spin-off some or all of their investment banking operations.
According to KBW's data second-quarter trading revenue for all U.S. bank holding companies totaled $21.9 billion, with JPMorgan in the lead with 24%, followed by Citigroup (20%), Goldman (18%), Bank of America (16%) and Morgan Stanley (13%). All other U.S. bank holding companies combined for the remaining 9% of second-quarter trading revenue.
With other rules soon to be implemented covering foreign non-bank trading firms, KBW expects total trading revenue for all firms to decline, and that "revenues currently at the large bank holding companies will be pushed out to non-bank broker-dealers and other security trading firms."
Here are quick valuation snapshots for the five firms KBW mentioned as well-positioned to benefit from Volcker and other coming regulations that could push the largest U.S. banks to radically change their businesses:
- Shares of Piper Jaffray closed at $38.00 Friday, returning 18% this year. The shares trade for 15.4 times the consensus 2014 earnings estimate of $2.47 a share, among analysts polled by Thomson Reuters, and for 15.0 times the consensus 2015 EPS estimate of $2.53.
- BlackRock closed at $301.83 Friday, returning 50% this year. The shares trade for 16.9 times the consensus 2014 EPS estimate of $17.86, and for 14.7 times the consensus 2015 EPS estimate of $20.60.
- KKR & Co. closed at $23.23 Friday, returning 66% this year. The shares trade for 9.4 times the consensus 2014 EPS estimate of $2.47, and for 8.5 times the consensus 2015 EPS estimate of $2.74.
- The Carlyle Group closed at $32.99 Friday, returning 32% this year. The shares trade for 10.3 times the consensus 2014 EPS estimate of $3.19, and for 9.0 times the consensus 2015 EPS estimate of $3.67.
- Springleaf Financial began trading on Oct. 16 at an opening price of $19.10 a share. The shares closed at $21.77 Friday, trading for 11.7 times the consensus 2014 EPS estimate of $1.86, and for 8.3 times the consensus 2015 EPS estimate of $2.30.
-- Written by Philip van Doorn in Jupiter, Fla.
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