As we know all too well, many of the biggest banks out there have been driven -- and at times driven to the brink -- by investment banking activity and dealing with complex financial instruments. But let's toss those banks aside for a moment and talk good, old-fashioned banking.
The banking landscape has been a rocky one over the past few years and the going still isn't exactly easy. Unemployment is high, which means that borrowers are more likely to default, "recovery" is probably not the word for what's been happening in the real estate market, and there are real fears that the economy may tip into a double-dip recession.
With all of this going on, should investors still be buying bank stocks?
Survey says: "It depends"
Sometimes an industry will have such a strong tailwind behind it that it's hard to go wrong with any pick in that group. It's hard to say that's the case with the banks right now.
While I expect unemployment to continue to slowly improve, it's not going to get better all at once. And I think anyone expecting a rapid recovery in the housing market probably had something slipped into their Wheaties (i.e., it's not going to happen).
Meanwhile, even though fears about financial reform have directed pessimism toward the huge banks like Bank of America
In other words, you have to be choosy.
Safety first
Some folks may like the idea of digging into the real muck for the cheapest of the cheap banks out there, hoping to find an ugly situation where pessimism has overshot the mark. The market's recovery over the past year has made these harder to come by, but I'm sure there may still be a few out there. However, without full access to the banks' loan portfolios, this requires more hoping and praying than I usually like to involve in my investments.
So instead, investors that venture into the banking industry should focus first on the bank's safety. This means, among other things, looking for banks that have high capital ratios and have been aggressive about provisioning against potential loan losses.
I've got your boring right here
To shake up some banking ideas that would fit this approach, I looked for banks whose provisions for loan losses were at least 90% of nonperforming loans and who have tier one capital of at least 10%. Past that, I looked for the banks that showed solid returns on equity during the previous peak and are currently trading at a discount to past valuations.
|
Bank |
Allowance for Credit Losses / Nonperforming Assets |
Tier One Capital Ratio |
2006 Return on Equity |
Price-to-Tangible Book Value |
|---|---|---|---|---|
|
PNC Financial Services |
92.3% |
10.3% |
26.8% |
2.08 |
|
BB&T |
93.8% |
11.7% |
13.4% |
2.08 |
|
KeyCorp |
107.3% |
12.9% |
15.6% |
1.07 |
|
Commerce Bancshares |
206.3% |
13.4% |
15.8% |
1.72 |
|
Bank of Hawaii |
380.8% |
15.9% |
25.5% |
2.64 |
Source: Capital IQ, a Standard & Poor's company.
What do we know about all of these banks right off the bat? They've all been conservative with their balance sheets and have made sure that they have the capital they need to easily handle credit losses and stay on the up-and-up with regulators. Each of these banks also has a franchise with the capacity to earn attractive returns on shareholders' equity. While conditions today are nothing like they were in 2006, I chose that year on purpose; if a bank wasn't earning attractive returns in '06, the business model probably isn't all that attractive.
What we also know is that -- with the exception of KeyCorp -- none of these banks looks particularly cheap. With price-to-tangible book value ratios approaching, or more than, two, it's very clear that investors have not overlooked the fact that these are higher-quality banks. However, what's also true is that all of these stocks traded at even higher multiples during the better times. So while they may not be trading at rock-bottom levels, I don't think all the upside has been squeezed out either.
Getting back to the question we started with: Should you buy bank stocks? Here's my suggestion. Check out the franchises listed above or some of the other similarly conservative, high-quality banks. Buy a bit at today's prices and hope that we get another round of pessimism that allows you to buy even lower. In the meantime some of these -- BB&T and Bank of Hawaii, for instance -- will even pay you a dividend for waiting around.
Share your favorite bank stocks in the comments section below.
