Which Big Banks to Buy

Today's investment environment is baffling. Is it a great opportunity, or a trap for the naively optimistic? This paradox is particularly prevalent among large bank stocks.

It's frankly doubtful whether one should buy the large banks in general at this point. However, one can make an argument to do so.

Time to buy?
Let's first examine some possible reasons a person might be foolish enough to start a big bank-buying spree. First, the overindulgence of most large banks in quick and easy subprime profits has caused a terrible banking crisis, making bank stocks cheap. How cheap? Banks in the S&P 500 were selling in March at just 1.2 times book value, the lowest ratio since 1991.

How have banks fared in past crises? Pretty well. In fact, in the two years following both the savings and loan crisis of 1990 and the long-term capital management crisis of 1998, bank stocks rose 50% from the bottom.

One of the most successful ways of making money in the market is by buying good companies in essential industries when they're out of favor. Well, banks are certainly out of favor. And the economy can't function without them. Also, some prominent people, including former Fed chief Alan Greenspan, have said that we may already be through the worst of the credit crisis. So, what are you waiting for?

Easy there, tiger
Although some have speculated that we may be through the worst of the credit crisis, they could be wrong. And, even if the worst is over, certain banks may have a long way to go before they're over it. Just last week, Meredith Whitney, the Oppenheimer analyst sent from the heavens to reveal the future, predicted that large write-offs and subsequent capital raisings for major banks could continue well into 2009.

But it's not just the write-offs. Because of reduced leverage and lower noninterest income, the major banks' future earnings power has been greatly diminished. Once the credit crisis fades, banks will return to a less profitable earnings world.

Also, the soft economy is decreasing business activity and increasing delinquencies on existing loans. In addition, banks are hoarding cash that they once used to generate loans and business activity, in order to shore up their capital reserves. The reduced business will lead to smaller profits. Combine these problems with the fact that many banks, including Citigroup (NYSE: C  ) and Wachovia (NYSE: WB  ) , have cut their dividend and diluted share holdings with equity offerings, and you have a bunch of good reasons not to like big banks right now.

What's worth buying now?
Are there any large banks that are worth buying here? Perhaps some of the more responsible banks, like Bank of America (NYSE: BAC  ) , JPMorgan (NYSE: JPM  ) , or Wells Fargo (NYSE: WFC  ) , which are withstanding the crisis relatively well, are worth a look. These banks have fairly secure dividends, and they will certainly be back. But it might take a while.

The only big bank that seems to stand out is US Bancorp (NYSE: USB  ) . Not only has its stock price held up, but its business model is superior as well.

US Bancorp is actually making a profit and growing revenue in this environment. It proves that a well-managed bank can actually resist the temptations of overindulgence that devoured most of the other large banks. USB has a clean balance sheet, a business model that provides a return on equity of 20%, and a secure dividend of more than 5%.

So there's only one standout in the group. Still, one might be all you need.

Related Foolishness:

US Bancorp, JPMorgan Chase, and Bank of America are Motley Fool Income Investor recommendations. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Tom Hutchinson holds no financial position in any companies mentioned. The Motley Fool has a disclosure policy.


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  • Report this Comment On June 02, 2008, at 4:13 PM, idickstein wrote:

    In Broard County Florida US Bank in one of the top three bank's in customer real estate default. I wonder in how many more county and state they have major real estate defaults. How do they publish those numbers. in a default the property goes back to the bank, how do they present it in their statements. do they an obligation to comment on it.

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