Where’s the Regulator?
From bashing banks to joining the ranks of big law firms that represent them, former regulators and fiscal policy makers are making the most of their connections to Washington.
Elizabeth Warren is campaigning for a U.S. Senate seat in Massachusetts as a Democrat after leading the creation and formation of the Consumer Financial Protection Bureau under President Obama. She handily won an overwhelming vote at her state convention and won’t have to face primary opposition. But if you listen to her, it almost sounds like she’s running against JPMorgan Chase & Co. CEO Jamie Dimon instead of incumbent Scott Brown, the Republican whose Senate seat she wants. She’s been calling for Dimon to step down from his seat on the board of the Federal Reserve Bank in New York after the company’s more than $2 billion trading loss.
Meanwhile, former U.S. Treasury Secretary Henry Paulson is kicking back a bit after the maelstrom that was the financial crisis. He didn’t take a job as a professor, but rather a “distinguished senior fellow” at the Harris School of Public Policy Studies at The University of Chicago, where he guest lectures and breakfasts with students.
He also wrote a book about the financial crisis and recently formed the Paulson Institute, a think tank on U.S.-China relations.
John Dugan, who was appointed by George W. Bush, left his job as Comptroller of the Currency in 2010 and rejoined his former law firm, Covington & Burling LLP (where he has appeared at Bank Director conferences as a speaker).
And last but not least, former Federal Deposit Insurance Corp. Chairman Sheila Bair is still worried about systemic risk in the banking system, so much so that she recently started spearheading a private group to put pressure on the regulators to finalize financial reform regulations that have been delayed. Paul Volcker, a former chairman of the Federal Reserve, is also involved. The group, called the Systemic Risk Council, is funded by the Pew Charitable Trusts and Chartered Financial Analysts. Bair also has been going after much maligned JPMorgan, saying the bank should voluntarily break itself up. We’ll be waiting to see if that happens.
Big Pay, Bigger Stock Options
How does your paycheck line up with those of the CEOs at the nation’s largest banks? JPMorgan Chase & Co.’s Jamie Dimon was the highest paid bank executive in 2011, with a $23 million pay package, up 11 percent from the year before. But most of that was in stock and option awards that vest over time, meaning the value could change. In fact, $17 million of it was in stock and option awards, versus just $1.4 million in salary and $4.5 million in bonus, according to SNL Financial LC.
Other CEOs at the nation’s largest banks were paid similarly high amounts in stock and relatively low amounts in salary (but not low by the average person’s standards). Wells Fargo & Co.’s John Stumpf was paid $19.8 million last year-$12 million of it in stock and option awards.
However, Citigroup’s Vikram Pandit was paid $14.9 million, and only $7.8 million of that was the value of stock and option awards. His bonus was $5.3 million, more than JPMorgan’s Dimon. Citigroup also was the one megabank that lost its shareholder say-on-pay advisory vote this year.
SNL Financial says companies in the face of tougher shareholder scrutiny are increasingly using stock options with longer vesting periods, to align pay with long-term performance, while paying smaller cash bonuses than in years’ past. Incentive compensation increasingly is tied to specific performance and strategic goals, while cash bonuses at the discretion of the board are losing favor.
The trend holds true at banks below $500 billion in assets as well. Capital One Financial Corp., which was the highest performing big bank in Bank Director’s 2012 Scorecard based on 2011 results, paid its CEO Richard Fairbank $18.7 million last year, almost all of it in stock and option awards, according to SNL. He wasn’t paid a salary or a bonus, as he hasn’t been for years.
After Dimon, Stumpf and Fairbank, the fourth and fifth highest paid bank CEOs were Robert Kelly at Bank of New York Mellon Corp., who got $17.6 million, and James Rohr of PNC Financial Services Group Inc., who was paid $16.6 million.
Assessing the Damage of Hurricane Durbin
Of the Dodd-Frank Act’s many provisions, none have had a greater financial impact on the banking industry than the Durbin Amendment, which directed that the Federal Reserve Board regulate the amount of interchange fees banks may receive for debit card transactions. In June 2011, the Fed set a cap on debit card swipe fees of 21 cents per transaction (plus an additional 0.05 percent of the value of the transaction to cover fraud-prevention costs)-approximately half of the average 44 cent per-transaction fee that banks were accustomed to getting before Durbin. The new rate took effect October 1 of last year. In an attempt to protect small banks from the economic impact of such a drastic reduction, institutions with less than $10 billion in assets were exempted from the cap.
With two full quarters of reported data (fourth quarter 2011 and first quarter 2012) available for analysis, it’s now painfully obvious that the Durbin Amendment has been the economic equivalent of a multi-billion dollar natural disaster for large institutions. Banks are required to disclose their credit card and debit card interchange revenue in their quarterly regulatory filings (if the dollar amount exceeds $25,000), which is public information. In fourth quarter 2011, the industry reported a $1.44 billion decline in interchange revenue compared to the preceding third quarter, according to Novantas LLC, a New York-based consulting firm. Large banks posted a similar decline in interchange revenue in the first quarter of this year as well.
Assuming this pattern holds, that adds up to approximately $5.75 billion in lost annualized revenue-and this is occurring when institutions of all sizes are already coping with severe margin pressure caused by low interest rates, and also with a significant decline in overdraft fees following implementation of new Federal Reserve overdraft protection rules in November 2009. Hardest hit of all, according to Lee Kyriacou, a partner at the consulting firm Novantas, have probably been regional banks in the $10 billion to $50-billion asset category. Highly diversified megabanks like JPMorgan Chase & Co. and Bank of America Corp. have more revenue sources than most regional banks, and therefore rely less on interchange revenue for their profitability. Megabanks miss the money-no question. But they are better able to cope.
“The biggest hit has really been to the mid-tier regional banks,” says Kyriacou. “That’s probably not what was intended, but that’s what has happened.”
Banks under the $10 billion threshold have not been directly affected as yet. According to Kyriacou, they reported $390 million in interchange revenue in the fourth quarter of 2011, compared to $400 million in the preceding third quarter. “Almost the entire decline has been at banks over $10 billion in assets,” he says. “For banks under $10 billion in assets, the numbers are flat.”
But will the under $10-billion exemption hold up over time? The American Bankers Association in Washington, D.C., certainly doesn’t think so. “That’s a snapshot in time that won’t hold up in the long run,” says Ken Clayton, the ABA’s executive vice president of legislative affairs and chief counsel. Clayton worries that large “big box” retailers, which account for much of the debit card activity nationwide, will find a way to drive most of their volume to the large banks that now operate under a price cap. “It’s hard to imagine a situation where a bank that charges twice as much [for a debit card transaction] as another bank will be able to sustain that,” he says. “There’s nothing in the law that says that community banks must get this preferred rate.”
It’s unlikely that any industry can have a $6 billion bite taken out of its revenue base and not undergo some fundamental changes. Interchange fees, and to a lesser extent overdraft fees, have helped subsidize a high-cost brick-and-mortar distribution system and popular products like free checking. Don’t be surprised if, say, 10 years from now the Durbin Amendment is seen as the catalyst that forced many banks to drastically change their consumer banking business models. Because it will be almost impossible for the industry to replace nearly $6 billion in lost interchange revenue-consider the consumer outrage that erupted when several megabanks tried to introduce modest debit card fees last fall-many banks will eventually be forced to rationalize their branch systems at an even faster rate than they’ve been doing in recent years, and adopt pricing structures for many of their consumer products and services that more accurately reflect their underlying cost. Less “free” and more electronic distribution would be one way of characterizing the shift that’s bound to occur.
“Will the [retail] banking model change over time because of this?” asks Novantas Partner Hank Israel. “The answer has to be yes.”