Trading the Changes to Dodd-Frank

Shutterstock photo

Yesterday, Congress passed a major overhaul of the Dodd-Frank bill, legislation originally intended to insure against another financial meltdown such as we saw in 2008. The House vote was, as we have come to expect these days, on party lines, but the analysis of the potential impacts by traders and investors should not be.

What they should be doing is looking at the potential impact of the overhaul on specific stocks, and if you do that, there are some clear opportunities as a result of the bill’s passage.

An unbiased analysis suggests that like many laws enacted in response to crisis, Dodd-Frank addressed real problems, but, due to abundance of caution, went a bit too far. Perhaps the best example of that is that is in what the law defined as “systemically important” financial institutions. The bar for that designation was set at $50 billion, which meant that relatively small regional banks were forced to comply with regulations designed to limit the risk of the big players, such as Bank of America (BAC) and Citibank (C).

One of the things that we learned during 2007-9 is that most of those regional and super-regional banks had a very different risk profile than their larger competitors. They were less dependent on trading as a profit source, were not as exposed to mortgage backed securities, and generally had better-looking balance sheets. Most, therefore, came out of the crisis in decent shape and have shown solid, if not spectacular, growth since them.

Ask a CEO of one of those banks, though, how the last ten years has been, and you will probably not receive a cheery reply. They feel that Dodd-Frank has unfairly held them back by forcing them to comply with regulations and reporting requirements designed for the massive multinationals.

Even many supporters of the law admit that that is the case. The $50 billion threshold for compliance was set at a time when bank assets in general were depressed, so many smaller banks were unintentionally subject to the law once assets in general recovered. Barney Frank, one of the architects of the original bill, now admits that $50 billion was too low.

There are a lot of controversial aspects to the new bill but raising the threshold for regulations to $250 billion is not really one of them. Some may argue that the new number is too high, as does Frank, but most believe that the old lower level placed far too high a burden on regional banks given the size of their operations. Logically then, the opportunities that emerge from the changes to Dodd Frank are in that area.

However, they may not be where you think.

It is natural to think that the biggest beneficiaries will be the bigger, super-regional banks such as BB&T (BBT) and SunTrust (STI) but in this case their size is a disadvantage. Both have assets in excess of $200 billion, so while they slip under the new threshold now, there is little room for growth in the near future if they wish to remain that way. And, they are vulnerable to even a small reduction in the limit by a future Congress.

In addition, their size means that the reporting requirements and regulations of Dodd-Frank had less of a relative negative impact on them than on some of their smaller competitors. For those banks, however, with assets closer to $100 billion, the reduction in operating costs will be significant, and a growth spurt can be expected.

This legislation didn’t come as a surprise of course, so the fact that one regional, Fifth Third Bancorp (FITB), announced their takeover of MB Financial (MBFI) a couple of days ago shouldn’t have been either. FITB dropped significantly on the announcement as is usually the case with buyers, but the lower levels reflect short-term pessimism and ignore the long-term benefits of growing under the new legislation. MBFI would therefore be my top pick to benefit from the more relaxed regulatory environment the overhaul promises.

If you are averse to companies involved in mergers there are still plenty of banks to choose from. Huntington Bancshares (HBAN), Citizens Financial Group (CFG) and Key Bank (KEY) all fit the bill and any one or combination of them would position you to take advantage of the changes. The important thing for investors, however, is to understand that the obvious picks will most likely not be the big beneficiaries of these changes. They are designed to help out smaller regional banks, and that is what they will do, so that is where you should be investing.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Referenced Symbols: FITB , KEY , CFG , HBAN

More from Martin Tillier



Martin Tillier

Markets, Bitcoin

Research Brokers before you trade

Want to trade FX?