Bank stocks as a whole have been beaten up so far in 2016. While I like the whole sector in general right now, there are a few particular bargains that stand out to me. Here are three banks I'd like to add to my portfolio, or add to my current position, right here and now.
A big fish in a small pond
One bank I find particularly interesting right now is New York Community Bancorp (NYCB -4.40%), which is a big player in a niche market. The bank's core lending business is focused on multifamily buildings in New York City, especially those that are rent-controlled or -stabilized.
This business model has worked out tremendously for the bank (and its shareholders) over the past few decades. Rent-regulated apartments are virtually recession-proof when it comes to tenant retention, and this stability can be seen in the bank's rock-bottom non-performing loan ratio, especially during tough economic times.
Source: NYCB company presentation.
Additionally, multifamily loans are cheaper to produce and service than other types, which has led to unheard-of efficiency ratios. During the first quarter of 2016, New York Community reported an efficiency ratio of 43.1%, while the banking industry averaged 62.8% (lower is better).
The reason I like the bank right now is that shares took a nosedive recently, when it was announced in October 2015 that it will be acquiring Astoria Financial (AF). While I still have a positive long-term outlook for the bank, this acquisition concerns shareholders for several reasons.
Data by YCharts.
For one thing, Astoria is nowhere near as efficient as New York Community (not many banks are), and since efficiency is a major competitive advantage, it's no wonder this is causing some concern. Also, the addition of Astoria will increase the bank's size beyond the important $50 billion regulatory threshold established by the Dodd-Frank Act, which means additional (costly) regulatory supervision. Finally, the bank has been paying high dividends for years in an effort to avoid the $50 billion threshold, and has no reason to keep doing this after the merger. The dividend has already been reduced, and further cuts are possible, which could be a turnoff to income seekers.
Having said that, New York Community's management has done a great job of delivering returns for shareholders, and I see no reason not to have faith in their plan going forward.
A short-selling target with big profit potential
BofI Holding (AX 1.31%) is a favorite among short-sellers. In fact, as of the latest data, more than 40% of the bank's outstanding shares were sold short. So it's fair to say that a lot of people don't agree with me on this one.
Data by YCharts.
The reasons for the pessimism are easy enough to understand. There were a bunch of allegations made against the bank in late 2015, including falsifying financial reports, risky lending, doing business with criminals, and even money laundering, just to name a few. Although the bank has thus far successfully refuted the charges, investors are still justifiably nervous, which has held the share price down.
However, the bank keeps producing results. During the first quarter of 2016, the bank's net income grew by an impressive 70% from a year ago, and earnings per share grew by 65%. Total assets grew by 40%, including 38% growth in deposits.
Since the bank operates online, it has lower costs than most of its peers and can operate more efficiently. In fact, the bank's net interest margin for the quarter was 4.02%, a full 100 basis points above the industry average of 3.02%.
While I'd call this the riskiest of the three stocks mentioned here, I personally think the short-seller's allegations don't have much basis in fact, and that it's only a matter of time before this high-growth bank gets the respect it deserves from the market.
This big bank won't stay cheap forever
Bank of America (BAC -0.07%) has rebounded quite a bit since its February low, but still trades for an extremely cheap valuation of just 64% of book value.
Data by YCharts.
The bank has come a long way since the financial crisis, in terms of credit quality, capitalization, and expense controls. It has also done a good job of growing deposits and its loan portfolio in a responsible manner. Just to name a few highlights, over the past four years the bank has grown its consumer deposit and loan portfolios by 23% and 52%, respectively. During the same time period, the bank reduced its non-interest expense by 23% and has reduced its net charge-off rate to just 0.48% of loans from 1.80%.
In fairness, there are several reasons for shareholders to be concerned. Most significantly, the bank is struggling to produce a decent level of profitability in the persistent low-interest environment. The bank's first-quarter return on assets of 0.5% is half of the industry's 1% benchmark, and until rates move higher, this is going to remain a challenge. Plus, low oil prices have caused concern about a potential wave of loan defaults since the bank has substantial exposure to energy lending.
While I certainly feel that a discounted valuation is warranted given some of the ongoing concerns I mentioned, such a steep discount to book isn't likely to last forever. All it would take to send Bank of America shares higher is a better interest margin, better-than-expected results from the energy loan portfolio, or any other factor that increases profitability to a respectable level.
Which is best for you?
The answer to this question depends on your risk tolerance, income requirements, and investment time frame. If high dividends are a priority and you'd prefer a well-established company with stable profits, New York Community Bancorp is probably the best bet for you.
On the riskier side, Bank of Internet (BofI) is a high-growth company facing some serious allegations and should be approached with that in mind, as well as given a long time horizon. And Bank of America investors need to have the risk tolerance (and strong stomach) to make it through the volatile times as the bank finds its path to sustainable profitability.
