All the chaotic news arising from the White House has distracted investors from what is the most significant change in nearly a decade. Not only is this transformation revolutionary, but it is also exceedingly bullish for the stock market.
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I am talking about the rollback of the draconian Dodd-Frank Wall Street Reform and Consumer Prection Act of 2010. Zeal to protect the public and financial system from another 2008 style systemic meltdown resulted in the passage of the bill. No one thought about the bearish ramifications on the financial industry.
Put simply, Dodd-Frank prevented banks from maximizing profits in the name of protecting the financial system and consumers.
Now that it is rolled back, specific stocks and sectors will likely benefit bullishly.
House Speaker Paul Ryan said the bill's passage was a step toward "freeing our economy from overregulation. Our smaller banks are engines of growth. By lending to small businesses and offering banking services to consumers, these institutions are and will remain vital for millions of Americans who participate in our economy."
This article will identify the sectors likely to benefit from the changes and provide specific stock picks for each industry. I will also provide my No. 1 stock pick based on the new regulations.
1. Small and Regional Banks
The rollback via the new bill will have the most significant impact on the small and regional bank sector. It effectively lowers Dodd-Frank regulations for small and regional banks via increasing the capital threshold for prudential standards, stress test demands and mandatory risk committees.
One of the facts that helped the rollback take place is the decline in community banks. Bank lenders dropped from around 8,400 in 2007 to approximately 5,500 in 2017. "This bill was perfectly crafted to allow greater flexibility for small community banks and credit unions...so it is purposeful that this bill does not include provisions for the largest banks," North Dakota Sen. Heidi Heitkamp, a prime sponsor of the bill, told Reuters.
The change increases the capital threshold from $50 billion to $250 billion for SIFI (systemically important financial institutions). However, the limit would be eliminated for institutions under $10 billion. Thereby, federal oversight is lowered for banks under $250 billion. At the same time, capital, lending, and trading rules are eased on small institutions.
I particularly like the fact that SIFI change is expected to increase organic and merger-related growth in the regional and small banking sectors. This will provide a competitive advantage to smaller institutions, giving them a fighting chance against the behemoth banks.
Currently, I like People's Utah Bancorp (Nasdaq: PUB), 1st Source Corporation (Nasdaq: SRCE), and East West Bancorp (Nasdaq: EWBC) as stocks likely to benefit in the small/regional sector.
2. Large Custodial Banks
It is important to note the differences between institutions that have custody of client's assets but do not act as lenders or investment bankers.
The new changes decrease the capital requirements for custodial banks, which are very bullish, as it frees up capital for growth/dividends. The capital requirement is the amount of liquidity a bank is required to hold and is set by the FDIC or FRB in the United States.
The largest custodian banks are State Street (NYSE: STT) and BNY Mellon (NYSE: BNY). Both these stocks stand to benefit from the Dodd-Frank rollback
3. Mortgage Credit
The new bill eliminates escrow requirements for residential mortgage loans held by a depository if conditions are met. Also, it guides Freddie Mac and Fannie Mae to institute alternative credit scoring methods beyond the outdated, tired and arguably flawed FICO score.
Not only will this aid mortgage companies and home lenders, but it may also trigger the next real estate boom. Imagine many current renters who failed to qualify for a mortgage under FICO gave a second chance to buy a home under the new scoring system. Indeed, only a percentage of the buyers will be eligible, but it will likely be enough to create upward pressure on the national housing market. In turn, the large builders like Toll Brothers (NYSE: TOL) and DR Horton (NYSE: DHI) stand to reap the profits.
Interestingly, builders like TOL have rolled out lower housing cost options fitting precisely with the demographic most likely to benefit from the new scoring system.
In the mortgage business, I like going right for the big daddy Freddie Mac (OTC: FMCC) as being very likely to benefit from the change. In fact, FMCC is my favorite choice right now in the $1.63 per share range. My target price is $3.00 per share with initial stops suggested at $1.23 per share.
Risks To Consider: It is critical to note that the possible new credit scoring system may not be implemented, and it may be more onerous than FICO for some. Be extremely cautious investing on speculation of future change.
Also, investing in the stock market is very risky. No matter how sure you are of a specific outcome, anything can and does happen. Always use stops and position size properly.
Action To Take: Consider adding one or more of the above stocks to your long-term portfolio!
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