The Two Safest, Best-Run Big Banks
By Anand Chokkavelu, CFA
The recent financial crisis made a lot of individual investors once-bitten-twice-shy on banks.
And for good reason. It's rare for an industry to run itself so badly that it can threaten capitalism itself. That's why the term "too big to fail" exists.
As the government effectively bailed out the banking system, bank investors were pounded by falling share prices, share dilutions, and slashed dividends.
The economy is looking much better and there have been banking reforms (both enacted and pending) since then, but the assets of many big banks still remain a black box. As a non-insider investor in a bank, you'll never know the exact makeup of a bank's loan portfolio. Worse, the Wall Street banks have large derivatives positions that make an already cloudy business absolutely murky.
The wheat from the chaff
However, of the largest seven American banks – JPMorgan Chase (NYSE- JPM), Bank of America (NYSE- BAC), Citigroup (NYSE- C), Wells Fargo (NYSE- WFC), Goldman Sachs (NYSE- GS), Morgan Stanley (NYSE- MS), and US Bancorp (NYSE- USB) – two stand out as the safest and best-run.
We can see this in their exposure to derivatives, the consistency of their profitability, and their returns on equity.
Whereas the other five routinely carry derivatives with notional values 30, 40, even 400 times their assets (hello, Goldman Sachs), Wells Fargo's derivatives are around three times its assets and US Bank's are around just one-third of its assets. At least on relative terms, this is comforting.
Adding to that comfort is the fact that Wells and US Bank remained profitable throughout each year of the financial crisis. Any exposure to derivatives or risky lending didn't hurt their bottom line enough for them to go negative.
Beyond that, their history of returns on equity (i.e., how efficiently they wring profit out of their operations) has been the stuff of legend. Currently, Wells' returns are at 11.9% and US Bank's are at 14.8%. Those aren't otherworldly figures, but they're strong in the current environment.
The Buffett endorsement
And if you need a Warren Buffett seal of approval, he had this to say in his latest Berkshire Hathaway (NYSE- BRK-B) shareholder letter:
Counting IBM, we now have large ownership interests in four exceptional companies: 13% of American Express, 8.8% of Coca-Cola, 5.5% of IBM and 7.6% of Wells Fargo. (We also, of course, have many smaller, but important, positions.) We view these holdings as partnership interests in wonderful businesses, not as marketable securities to be bought or sold based on their near-term prospects.
One of these "smaller, but important, positions" is in US Bank, of which Berkshire owns 4.1%.
Those are strong endorsements from the man whose first rule is never to lose money.
The bottom line
While I'm personally bullish about the banking sector in general and think there's money to be made in many of the largest banks, Wells and US Bank are operationally the safest, best-run banks.
Anand Chokkavelu owns shares of Bank of America, JPMorgan Chase, Citigroup, and Wells Fargo. He owns warrants in JPMorgan Chase, Citigroup, and Wells Fargo, and long-dated options in Bank of America. The Motley Fool owns shares of Bank of America, International Business Machines, Citigroup, Coca-Cola, Berkshire Hathaway, and JPMorgan Chase. The Fool owns shares of and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo, Berkshire Hathaway, Coca-Cola, and The Goldman Sachs Group. Motley Fool newsletter services have recommended creating a write covered strangle position in American Express. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.