they still feel good about the trajectory of used car prices. While inventories have picked up a bit over the past few months, inventory levels are still below where they were pre-pandemic and are still below where they would have expected at this point in the cycle.
In sum, we would continue to argue that the auto concerns that have been plaquing the market post Tricolor/KMX are specific to where you originate (prime/super prime vs. sub-prime) and when you originated those loans. We believe that the large regionals have been disciplined in their auto lending and would point to the commentary by Wells that they believe there is room to move selectively down the FICO band as the risk/reward still makes sense. You’re likely not making that decision if you’re broadly concerned about auto credit.
As it pertains to credit more broadly, the feedback from the presenters continued to be quite positive both on the commercial and consumer sides of their books. A few anecdotes:
Citizens Financial (CFG): Very little to be concerned about right now on the commercial side (CRE charge-offs continue to flow through). On the consumer front, NCO’s in the high 40bp range currently are set to move down to the high 30’s over the next 18 months partially helped by their non-core rotation out of auto but also due to normalization post-Covid. Like WFC, CFG made the argument that their card business is modestly undersized and recently expanded their product set with 4 new card offerings. Leaning in not only in card but also in home equity lines of credit where they are a market leader. In terms of credit, 35% of CFG’s HELOC book is first lien with average FICO’s in the high 700’s and cumulative loan to values sub-60%.
KeyCorp (KEY): Super-prime lender on the consumer side of the house with average FICO on the consumer book of 790/resi mortgage north of 800. Like CFG, KEY mentioned that home equity lines of credit are an area of prospective growth given the all-time high in home equity in the U.S.
M&T Bank (MTB): M&T noted the long run the industry has had without material credit issues. While the growth in non-bank financials has been a positive, M&T noted that the transparency and the ability to determine systemic leverage has been diminished. To the extent transparency can be improved, it’s an opportunity to feel better about viewing the recent credit blips as isolated and not a reason to alter your growth trajectory.
PNC Bank (PNC): Similar to CFG & WFC, PNC acknowledged that their card market share with their own prime/super-prime clients is still well below where it needs to be and have been leaning in on the hiring front as well as adding management talent to the ranks to work through a multi-year journey to becoming the #1 card provider for their core PNC customers.
Regions Financial (RF): RF reiterated ~$300mm of runoff remaining in ’25 which clears the runway for unimpeded growth ‘in ’26. Moreover, RF is not seeing any signs of distress beyond the $300mm portfolio of interest. Recall that while the 4Q NCO’s will continue to be a bit elevated, criticized loan balances dropped by 20% QoQ, all setting up for an improved trajectory into ’26.
First Horizon (FHN): FHN noted 9 years worth of coverage at current charge-off levels, and the building of the reserve has been due to the adoption of the more downbeat Moody’s scenarios. They are hopeful that they are at the peak of building provision and that all things being equal, it should decrease from here.
Regulatory Backdrop
- A wide-ranging panel discussion with Rodgin Cohen, Senior Chair of Sullivan & Cromwell addressed the improvement in the regulatory environment under the new administration. A few of the highlights in no particular order:
- M&A Outlook – Regulatory has gone from skeptical to encouraging. Timelines have shortened substantially. The biggest negative factor right now is the market reactions to deals. Has cast a cloud over future transactions.
- Change at the Federal Reserve Board – The thought process here is that with Powell likely out post the end of his chairmanship, is it possible that it becomes a more populist Fed that is potentially not enamored with large deals. Regardless of that possibility, the argument was simply that the current environment is at it’s most conducive right now to transact.
- Private Credit – The banking industry has lost substantial share to private credit. What happens if private credit firms have a problem? Should you regulate them? More disclosure is probably the best for all involved. The large players (BX, KKR, APO) already have substantial disclosure. Can some of the bank regulations be modified for private credit? As M&T mentioned during their presentation, having a better picture of what is within the banking space as well as what is outside, is good for all involved from a systemic risk standpoint.
- Asset Threshold changes – While timing is uncertain, the conventional wisdom is that the $10b/$100b/$250b thresholds will likely all be raised (especially the $10b/$100b). The $10b likely goes to $20b-$25b and the $100b likely goes to $150b/$200b. It also appears that the long-term debt proposals are off the table taking away a significant potential earnings headwind for the banks. Side note – the $10bil Durbin interchange threshold likely remains unchanged at the $10bil level given the power of the retailers.
- Basel 3 Proposal/GSIB Surcharge: Some time in ’26 but will likely be capital neutral. The SLR will likely be adopted as proposed which will be capital friendly. On the GSIB surcharge, there is probably some room to move down but not sure how much as of yet.
- Genius Act/Stablecoin: Regarding the Genius Act, most of the authority is delegated to the OCC. Rodgin Cohen believes that every bank should be focused on the impact of stablecoin. He believes that stablecoin will take from bank deposits and viewed it as a major threat to the banking system. While international transfers make perfect sense, the extent to which the impact could be broader is the extent to which stablecoin can pay interest or rewards. To that end, will it be limited to the current crypto ecosystem or does it expand to the large technology/retail incumbents who can lose money for a time in order to build their franchises/become a competitive threat to the banks? Time will tell but the banks will need to evolve strategies here to protect their franchises from being disintermediated.
Loans to Non-Depository Financial Institutions (NDFI’s):
- A popular topic at the conference this year, each bank walked through their NDFI exposures in an attempt to provide more detail and demystify this new regulatory call report item.
- A few datapoints on the topic:
- WFC: Hard to draw conclusions from a few issues. Haven’t found anything that they’re concerned about. Bigger brand names on the capital call lines business – feel very good about the risk/return. Do provide financing to private credit lending to middle market firms – 2,800-3,000 loans. Investment grade “A” attachment point that they underwrite individually. Haven’t found anything that they would change – feel very comfortable with what they’re doing in that space.
- FITB: Has not been a rapid growth asset class. $10.2bil portfolio or 8% of loans. The top 3 (70%) haven’t had a loss in 10 years. Private capital – been cautious on from a growth perspective. Hasn’t been tested through a cycle yet so prefer to be extend credit only with the best partners in the space.
- KEY – First, it’s important to note that they did not grow $12bil last year. It was a call report reg reporting item. $18bil in total. $7bil is spec fin lending business (lending to lenders – had 1 loss in 20 years) which has robust fees and one which they will continue to grow. $6bil w/REITS. 97% investment grade. It’s a 40% LTV/3x fixed cost coverage, $3bil of insurance/finance customers – running claims/processing operations. $1bil of uni-tranche funds which is a way to compete with the direct lenders. It is an off-balance sheet fund where they have 12.5% equity (87.5% with a JV partner) and are the senior lender to the facility. Have grown it just a bit below the overall C&I portfolio growth this year (~$700mm Q1-Q3) and will continue to remain selective.
- PNC – lowest risk in their entire book.
- 20% of loans – $60bil – 95% investment grade/zero loss rates/zero criticized.
- 40% is asset securitizations such as trade receivables, securitizations, CLOs (bankruptcy remote, spv’s – have had zero losses since 1995). Checked through all the collateral. No issues.
- 30% – Capital commitment lines (old SBNY) – short term commitment secured by the capital commitments of pension funds, institutions, high net worth individuals – zero losses.
- 15% real estate (REITS, etc) – virtually no losses.
- 15% all other (loans to insurance, true financial institutions, mortgage warehouse lines, some equipment leasing, no subprime consumer or anything along those lines).
- 20% of loans – $60bil – 95% investment grade/zero loss rates/zero criticized.
- RF: $11.5bil in NDFI/70% investment grade the majority of which is their REIT book. Has been pretty stable in aggregate. On the securitization side, RF does transaction testing, touching ~1/3 of the book every year and then brings in audit on the underlying asset within 90 days of close.
Our Takeaways from BAAB this year….
- Consumer – In the case of the consumer, 2 narratives continue to coexist. Prime/super-prime customer balance sheets continue to be in good shape with employment relatively steady. Spending actually strengthened in 3Q and cash buffers are back to pre-pandemic levels. Mortgage/card/auto delinquencies and charge-offs remain benign. Banks are leaning into card and auto lending with WFC actually moving down FICO – something we wouldn’t expect to see if there were credit issues. At the same time, lower income consumers continue to struggle with high inflation and lack of real wage growth. While the “K” shaped economy continues, banks have largely limited their exposures to subprime customers, hence the improvement in underlying credit metrics.
- Commercial credit – also largely benign ex-CRE runoff. In addition, we think the market will feel better about the NDFI category given not only the additional disclosure, but the framing of the credit history by cohort.
- Regulatory Backdrop – As good as it gets. Raising the asset thresholds, the potential to lower the GSIB surcharge, taking the long-term debt proposals off the table all help accrue to a favorable M&A backdrop and lower run rate costs for the banks. That said, more transparency for the non-bank financials in the form of better disclosure would most likely help both bank and non-bank valuations. Lastly, the rise of stablecoin has the potential to be an existential threat for the banking system should a solution for the paying of interest/rewards be reached. While this will be a longer term evolution, banks will need to develop strategies to evolve with stablecoin otherwise run the risk of having their deposits cannibalized.
In sum, we believe that the benign regulatory environment and better capital regime will continue to accrue to the banks. The recent long end yield curve steepening will also help on fixed rate asset reprice and the capital markets backdrop continues to be robust right into the 4th Q. The recent credit driven correction from September we believe opens up an attractive entry point for the stocks. We believe they will not only benefit from the fundamental trends we are seeing currently, but also the enhanced disclosure around NDFI loans which over time we expect will assuage investor concern. We continue to remain positive on the regionals with the large caps trading at ~10x ’26 for 16% return on tangible common equity and the mid-caps trading just below 11x ’26 for a similar ~16% ROTCE. We reiterate our sector outperforms on RF, FITB, EWBC & WTFC.
