Most recently, both the House and the Senate passed sweeping financial overhauls which include more stringent rules on lending, increased debt to capital ratios on large financial institutions and refinements in the regulation of derivatives markets. The two bills are similar in nature, are expected to be merged into one by the end of the summer and will likely have an influence on the financial sector.
On the lending forefront, both bills will make it extremely difficult for mortgage brokers to make money on high interest loans and will require loan seekers to demonstrate and prove their ability to make monthly payments via paycheck stubs or other financial security. Additionally, both bills call for a new consumer watchdog to oversee all lending, in which the House sets up a stand-alone Consumer Financial Protection Agency with rule writing powers and the Senate set up an independent bureau within the Federal Reserve.
In regards to debt to capital ratios, bills passed by both the House and Senate require banks to hold more money to cover their debts. The House calls for a specific leverage cap on financial institutions of 15:1 debt-to-net capital ratios, whereas the Senate calls for banks with more than $250 billion in assets to meet the same capital standards as those that apply to smaller banks.
As for the derivatives markets, both sets of bills require derivatives to lose their unregulated status and be traded or cleared through an exchange. The Senate’s version includes a provision that would force banks to spin off their entire derivatives business, meaning that banks will be unable to make their own derivatives bets or bets for their clients. The House’s bill is similar, but it includes more exceptions to the rule for corporations.
At the end of the day, both bills have are aiming to set tougher rules on the financial sector, but leaves some weaknesses in the system unaddressed. Some hybrid version of these two bills will be signed into law in the coming months and will influence the following equities:
- Financial Select Sector SPDR (XLF), which boasts Bank Of America (BAC), Wells Fargo (WFC), JP Morgan Chase (JPM), Citigroup and Goldman Sachs (GS) in its top holdings. These firms are the big players in the lending industry as well as carry nearly 80% of the derivative assets and liabilities. XLF closed at $14.75.
- iShares Dow Jones US Financial Sector (IYF), which also holds the previously mentioned firms as its top holdings, but in a less concentrated manner. IYF closed at $52.90 on Friday.
- Vanguard Financials ETF (VFH), which allocates nearly 31.9% of its assets to the five companies most likely to be influenced by the financial reform. VFH closed at $30.26
If invested in these equities, it is important to utilize an exit strategy which identifies price points at which systemic risk may push values down. According to the latest data at www.SmartStops.net, the price points for the aforementioned ETFs are: XLF at $13.60; IYF at $48.78; VFH at $27.09. These price points are reflective of market volatility and change on a daily basis.
Disclosure: No Positions