Activist investors are increasingly campaigning against U.S. financial institutions (FIs), a move driven by changes in the activists' approach and an increased alignment with regulatory objectives, according to Fitch Ratings.

While traditionally focusing on more lightly regulated sectors such as corporates and, to a lesser extent, nonbank financial institutions (NBFIs), activists have now also turned to other more highly regulated FIs. Activist campaigns against FIs remain constrained by regulatory limitations on capital extraction, which run counter to one of activists' primary modes of increasing investment value, returning capital to shareholders via share repurchases or dividend increases. Nevertheless, several trends have emerged suggesting more activism may be on the way.

First, activists pursue breakups or strategic alternatives to increase value, aligning with regulators' general preference to see FIs, particularly those deemed to be systemically important, become smaller. Carl Icahn's involvement with AIG, Lion Point's involvement with Ally Financial, Hudson Executive Capital's involvement with CIT Group and Comerica, as well as Trian's involvement with General Electric Company are all recent examples of activist campaigns seeking to maximize investment value through full or partial breakups of the target company. Ally, AIG, CIT, Comerica and GE's finance subsidiary all exceed the $50-billion-asset threshold, which results in increased regulation and capital planning requirements.

Second, activists have increased their focus on NBFIs such as business development companies (BDCs) and finance companies, which often face less stringent regulatory frameworks than banks. Activists have argued for changes related to governance and share price valuations at BDCs including American Capital, Fifth Street Finance and TICC Capital, and for board representation via proxy contests at finance companies like Javelin Mortgage Investment and Walter Investment Management to effectuate changes including the exploration of strategic alternatives.

Third, certain activists have sought to take more collaborative stances with the existing management teams of target companies to increase value through improving the strategy or operations, rather than capital extraction, a tactic which could be more palatable to regulators. For example, ValueAct, which describes itself as a constructive activist, took a stake in American Express in August 2015, while Blue Harbor Group, which describes itself as taking a collaborative approach to active investing, took a stake in Investors Bancorp in April 2015. Whether or not friendlier activists will have sustained success targeting financial institutions remains to be seen.

Since 2009, NBFIs have generally benefited from an extended period of low interest rates and less competition from banks, although profitability has been unexceptional. Strong asset quality and evolving competitive dynamics have limited the number of underperforming FIs activists could potentially target. However, as the credit cycle turns, FIs experiencing underperformance and/or stock price declines could be increasingly exposed to activism. One possible buffer could be the recent underperformance of several high profile activist funds, which could reduce their available capital to deploy and/or draw their focus toward improving existing investments rather than pursuing new ones.

Activist campaigns on Fitch-rated entities do not typically have a rating impact unless Fitch believes an activist has a credible chance of implementing changes that would be materially adverse to creditors. A rating action may be taken to the extent that Fitch believes the credit risk profile has or will deteriorate depending on the potential likelihood and timing of activist actions.