NEW YORK (TheStreet) -- Regulators continue to tighten the screws on big banks like Bank of America (BAC) , JPMorgan Chase (JPM) and Goldman Sachs (GS) , and investors just aren't getting paid to take the risk.
The latest salvo came Tuesday from Federal Reserve Governor Daniel Tarullo, who told Congress he wants to increase capital requirements on "too big to fail" banks. Tarullo's comments prompted a shrug from Morgan Stanley analyst Betsy Graseck, who wrote in a research note that the regulator has been making statements like this for at least three years.
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Still, many analysts and the market viewed the comments as newsworthy, and big bank stocks, especially those of Goldman and Morgan Stanley, were weaker Tuesday, though they were recouping those modest losses in early trades on Wednesday.
"Every time you sort of get the green light to go, maybe the Bank of America settlement was one of those things, you know, you get another red light here like OK it's flashing danger and who knows what that means?" says Anton Schutz president and CIO of Mendon Capital.
Schutz, who invests exclusively in financial companies, says he would look to buy shares of Goldman Sachs or Morgan Stanley if they got substantially weaker on this news, but that seems unlikely at this point.
"Too big to fail" banks currently in his portfolio are Citigroup (C) and Bank of America, but he concedes the ongoing onslaught of new regulations adds to the appeal of smaller banks. Examples of those in his portfolio are Fifth Third (FITB) , Regions Financial (RF) and Synovus Financial (SNV) .
Smaller banks will be able to increase market share in areas like commercial and industrial lending as tougher capital rules make some loans uneconomical for the bigger players, according to Brian Kleinhanzl, analyst at Keefe, Bruyette & Woods (KBW).
Smaller banks tend to be more expensive on a price-to-book and price-to-earnings basis. The KBW Regional Banking Index, for example, trades at 1.35 times book value, while the KBW Bank Index, which includes the largest banks, is at 1.11 times book value. Still, Kleinhanzl argues the relatively higher price is worth paying.
The big banks "are not necessarily that much cheaper relative to where they've traded at historically. I would say that because of the outstanding regulatory issues as well as litigation that right now investors should be looking to the regional banks," Kleinhanzl says.