Dodd-Frank: Reform or Restriction?

“And remember this: What’s good for the banks is good for the country.”

That’s the lone villain, Henry Gatewood, in John Ford’s 1939 classic Stagecoach, pontificating just before he absconds with $50,000 embezzled from his bank.

Ford held up Gatewood before a Middle America that, by then, had been torn by 10 years of depression – including high unemployment, daily bank failures and ruinous foreclosures.

There’s a long and well-founded anti-bank/anti-banker tradition in the United States that indeed predates the Declaration of Independence.

That tradition was renewed with the Global Financial Crisis of 2007 through 2009.

Main Street’s well-being was then – and is now – secondary to Wall Street, which has captured the Inside-the-Beltway crowd, with the Mainstream Media completing a destructive triumvirate.

But let’s not do what the folks who wrote the law did. Because the most sweeping changes to financial regulation since the Great Depression threw the small banks out with the bathwater.

As if we needed additional reminders that Big Government is clumsy and dumb, consider the cudgel that is the Dodd-Frank Wall Street Reform and Consumer Protection Act.

If ever there was a need for a regulatory scalpel, separating the “Too Big to Fail” institutions from the banks that are helping small towns and normal people grow is the operation.

And Dodd-Frank has had a disproportionate impact on institutions that provide credit to the real economy.

As Sheila Bair noted in a Jan. 7, 2016 commentary for American Banker, regulators’ first rule-making to strengthen capital standards primarily affected community and regional banks. Tougher capital rules for the largest systemic institutions weren’t completed until 2015.

Highly complex “stress tests” consuming hundreds of man-hours were foisted on smaller, traditional lenders. Supervisory approaches designed for the largest institutions were simply copied rather than adapted for a quite different set of banks.

“And remember this: What’s good for the banks is good for the country.”
-Henry Gatewood, Stagecoach (1939)

It meant that banks smaller than the Citigroups and JPMorgans of the world were forced to adopt new processes and systems, with additional compliance staff further driving up costs. Regulators also “indiscriminately lumped” Main Street banks with Wall Street behemoths.

The Consumer Financial Protection Bureau’s “qualified mortgage” rule has caused the most aggravation for small-bank management teams, with compliance spending skyrocketing due to new mortgage rules.

Neither processes nor underwriting have changed much. But there’s a lot more paperwork involved. And there’s evidence indicating that banks are now paying premiums to bring in new compliance officers because of growing demand for that skill set.

Dodd-Frank also granted regulators authority to set higher thresholds for “enhanced” supervisory tools and to tailor those tools to the risks posed by individual institutions.

Only recently did bank regulators choose to use this discretion, when Federal Reserve Chair Janet Yellen announced that the central bank would ease up on institutions with assets of less than $250 billion.

Even as regional and community banks are getting squeezed between increased regulatory burdens and years of near-zero interest rates, there’s a solid investment case to be made for the group.

Consolidation is one potential catalyst for higher share prices. Smaller banks struggling with Dodd-Frank and other regulatory costs will be among the targets. Larger operators in the sector are acquiring smaller banks in an effort to increase profitability and control costs.

And Mitsubishi UFJ Financial Group Inc.’s (MTU) Bank of Tokyo-Mitsubishi, struggling amid Japan’s negative interest rates, is looking at potential acquisitions of U.S. regional banks to stimulate growth.

Smart acquirers will be able to efficiently expand their asset bases and better defray their costs.

That’s what First Commonwealth Financial Corp. (FCF) is doing with the addition of 13 branches with $735 million of deposits and $115 million of retail and business loans to its Ohio operations in a deal with FirstMerit Corp. (FMER).

First Commonwealth – based in Indiana, Pennsylvania, where Jimmy Stewart went to college – will reduce FirstMerit’s loan-to-deposit ratio below 100% and boost its net interest margin.

And it’s expected to be immediately accretive to First Commonwealth’s earnings per share.

The company, which operates more than 100 community offices throughout western and central Pennsylvania and central Ohio, is yielding 2.9% at these levels.

Even as regional and community banks are getting squeezed between increased regulatory burdens and years of near-zero interest rates, there’s a solid investment case to be made for the group.

As of March 31, 2016, there were 5,289 commercial banks operating in the United States, the lowest count since the Great Depression.

That’s down from 5,338 at the end of 2015 and 7,397 10 years ago. At the end of 1990, there were more than 12,000, and in the 1980s there were more than 18,000.

The “shrink” rate has accelerated from an average of about 3.5% per year to more than 4% since 2010, the year Dodd-Frank became law.

So it may not be “eviscerating” small banks. But it sure isn’t helping them.

According to the FDIC, during the first quarter there were 52 bank mergers. That’s roughly the same pace as 2015, when there were 264.

Even as the number of commercial banks continues to shrink, though, deposits are rising – fewer and fewer institutions are sharing a bigger and bigger market.

The prospect of rising interest rates is another potential catalyst.

New York Federal Reserve President William Dudley said in a speech on Monday that investors shouldn’t “rule out” a hike or two this year.

Higher interest rates help banks because net-interest margin – the spread between their borrowing rates and their lending rates – increases.

Regional and community banks are more sensitive to the prevailing interest rate environment because they derive a higher proportion of their income from deposits and lending activity.

Finally, regional banks are also a good source of dividend income – they’re better capitalized, and their balance sheets are sound.


Renewable energy projects in sub-Saharan Africa have attracted more than $25 billion of investment. The African Union recently announced a plan to invest another $20 billion.

Maybe more impressive, however, are the $35 upfront fee and $0.50 per day charge that off-the-grid Ugandans, Kenyans, and Tanzanians pay to get electricity from solar startup M-Kopa.

About the size of an iPad mini but a few inches thicker, M-Kopa’s home solar energy system provides three lights, five USB connections for phone charging, and a portable radio.

In the absence of the hundreds of billions of dollars necessary to fund the buildout of a new power grid, M-Kopa’s tech is helping overcome one of the major impediments – the lack of regular electricity – to Africa’s development.

While at first glance, these might seem like one-off efforts, they’re more likely early indicators of a new energy infrastructure that may become mainstream. It is indeed scalable across the developing world, which is, in turn, driving global population growth.

Smart Investing,

David Dittman
Editorial Director, Wall Street Daily

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