Roundtable: Which Banks Are Buys?

If you're like us, you've been following the financial sector very closely; as banks go, so goes the economy.

And if you're really like us, you're wondering whether all this rubbernecking can be turned into profit making. So we asked our banking analysts. Then we asked them to name names. Enjoy!

Are you bullish or bearish on finding value in the banking sector right now?

Morgan Housel: I'll admit that there's value somewhere in the banking sector, but I'm still keeping my distance.

Why? Because I sincerely question how effectively individual investors can perform due diligence on a bank, regardless of intelligence or focus. Crack open Merrill Lynch's 2005 annual report and see how much data you can find on its collateralized debt obligations (next to nothing.) Or check out AIG's (NYSE: AIG  ) 2005 annual report and see how much detail it goes into regarding credit default swaps (almost none). It's extremely difficult, if not impossible, for individual investors to ascertain what's lurking on a bank's balance sheet.

So until things like regulatory reform and disclosure are overhauled, I'll happily keep my distance. If that means foregoing what in hindsight turns out to be a 10-bagger, so be it. 

Alex Dumortier: Resolutely bullish! The fire sale prices of the March market low are no longer on display but the environment has improved as well and there is still a tremendous amount of uncertainty weighing on the banking sector. Investors continue to grapple with large unknowns: potential future loan losses and the steady state profitability of banks in a post-crisis world.

Among the ten sectors in the S&P 500, financial stocks display the second highest variability in terms of their price-to-book value multiples (after industrials) -- that spells opportunity.

Matt Koppenheffer: In short, I'm bullish. There is no doubt that banking will continue to be important to the U.S. economy and many of the major banks will be showing considerable profits a few years down the road. It's also not much of a stretch to say that banks are trading at lip-smacking multiples -- on a book value basis many banks like JPMorgan Chase (NYSE: JPM  ) and Wells Fargo (NYSE: WFC  ) are trading below their normal valuation ranges, while some of the more troubled banks like Bank of America (NYSE: BAC  ) are trading well below book value.

The catch though, is figuring out which banks are the best bets to have the fewest skeletons in their closets, and for that reason I would prefer to put a few eggs in my banking basket.

Anand Chokkavelu: There's a lot of opportunity in banking. Any time there's this much volatility, there's opportunity. Look at the 52-week ranges of three representative big banks:

  • Citigroup (NYSE: C  ) ($0.97-$23.50)
  • Wells Fargo ($7.80-$44.75)
  • Goldman Sachs (NYSE: GS  ) ($47.41-$186.83)

You're reading that correctly. At one point this past year, you could have paid one-fourth what someone else paid for Goldman Sachs stock. The spread gets bigger with Wells (around one-sixth) and utterly ridiculous with Citigroup (less than one-twentieth)!

Imagine me buying the same flat screen TV you did, but for $50 instead of $1,000 and you get a feel for the vagaries of Mr. Market.

So the opportunity is there. The questions you have to ask yourself: 1) are banks in your circle of competence, and 2) which banks are the best bets? For no. 2, I'll provide some help with my answer to the next question.

Name one bank that's interesting enough to research further and one that you wouldn't touch.

Morgan Housel: Well, I just admitted that I'm keeping my distance from banks, but I'll play along anyways.

Bank of New York Mellon has a very unique business model, and is too often lumped in with its failed peers. It's primarily a banker to other banks and institutional investors, rather than consumers and businesses. This kept it away from most of the boom-year insanity that's pummeling other banks. I think it's an intriguing model that could still do well in the years ahead. 

Those I wouldn't touch? They're not banks, and it seems obvious, but this is an important point to make: The odds that Freddie Mac or Fannie Mae (NYSE: FNM  ) will ever have one penny left over for common shareholders is as close to nil as it gets. Fannie's own annual report admits it stopped trying to turn a profit altogether. That shares are still listed on an exchange is a disservice to investors.

Alex Dumortier: As I noted in an article published earlier this week, paying a mere 2% premium to book value to own shares of JPMorgan Chase certainly looks intriguing. The bank is emerging as one of the winners of the present crisis and Jamie Dimon has shown he is arguably the most talented CEO of a large bank in the U.S.

Prior to this crisis, the last time the stock's price-to-book value was where it is now was in March 2003. Since then, the annualized total return on JPMorgan Chase shares has been 13.8% -- besting the S&P500 by more than 8.5 percentage points annually than over the same period.

As far as banks I wouldn't touch, I won't single one out, but I will recommend investors be extremely cautious when it comes to any bank with significant exposure to commercial real estate. The cycle of losses on related loans and securities is far from over; regional banks such as SunTrust Financial, Comerica and Zions Bancorp could face painful writedowns.

Matt Koppenheffer: Wells Fargo is probably at the top of my list in terms of the bigger banks. It was more conservative than most through the boom times and seems to have weathered the storm better. Of course, its valuation reflects that and so you can't expect the same kind of returns that you would from, say, a resurgent Citigroup.

And speaking of Citi, that's one of the banks that I'm least interested in. Before the crash it certainly was a huge bank, but I never considered it the best in any of its business lines -- and recent performance hasn't changed my opinion. The heavy government involvement with the bank probably concerns me more though, since Uncle Sam is more concerned with avoiding public outcry than in running a sound bank.

Anand Chokkavelu: Banks get more complex the bigger they get. Small community banks that take deposits and make loans aren't that hard to grasp. But banks with huge operations and huge derivative portfolios are very difficult to get comfortable with; once you get to full-blown investment banks like Goldman Sachs, you're valuing risk machines, not banks.

Unless you believe the Goldman conspiracy theories, I'd stay away from it and Morgan Stanley. They're simply too opaque.

For my pick for further research, I'll stick my neck out with a small upstate New York-based bank I bought on weakness a few weeks ago: Community Bank System. I ran across it researching an article I wrote a couple months ago. In their words, they are "free of exposure to subprime or other higher-risk mortgage products within our real estate and investment portfolios." They are heavily provisioned for any losses, have a higher than average net interest margin, and are roughly equally weighted among commercial, residential, and consumer loans. Let me know what you think after you've done your research.

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This roundtable article was compiled by Anand Chokkavelu. Anand owns shares of Community Bank System and Citigroup. The Motley Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (69)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 30, 2009, at 10:35 AM, dudemonkey wrote:

    How does one value a bank? That would be an outstanding article for intelligent investors.

  • Report this Comment On July 30, 2009, at 11:53 AM, ayamore wrote:

    I think your wrong about Freddie Mac and Fannie Mae both. Since when has any bank or institution quit trying to make a profit? The government is bailing out both of the above, and down the road they will make a huge comeback. I am buying up all I can and will hold for the LONG term.

  • Report this Comment On July 30, 2009, at 12:08 PM, TMFHousel wrote:

    ayamore,

    "Since when has any bank or institution quit trying to make a profit?"

    Since they were taken over last summer. From Fannie's annual report:

    "Prior to the conservatorship, our business was managed with a strategy to maximize shareholder returns. However, our conservator has directed us to focus primarily on fulfilling our mission of providing liquidity, stability, and affordability to the mortgage market and to provide assistance to struggling homeowners. In support of this focus on our mission, we may take, or be directed by the conservator to take, a variety of actions that could adversely affect our economic returns, possibly significantly."

  • Report this Comment On July 30, 2009, at 12:35 PM, UltraContrarian wrote:

    My opinion: 80% of good bank investment opportunities are outside the US such as SHG, WBK and NBG. But most are not even listed on US exchanges. Furthermore within the US, 90% of good bank investment opportunities have market caps less than 100M.

  • Report this Comment On July 30, 2009, at 3:49 PM, slpmn wrote:

    If the giant i-banks are ever forced to abandon or at least revise their tradition of paying bonuses based on a percent of revenue rather than net earnings or profitability, they will immediately become better investments. I'm interested to see how the "say on pay" legislation impacts them, if at all. Until the compensation system changes, they will always be agents of the boom and bust cycle, and more importantly, mediocre investments on a risk/return basis.

  • Report this Comment On July 30, 2009, at 5:38 PM, robba67 wrote:

    Now THAT is a good article! Some real analysis and opinion, free of product hype.

    More, please.

  • Report this Comment On July 30, 2009, at 7:46 PM, LessGovernment wrote:

    Poor, poor ayamore.

    You just don't get it. Obama's latest program to "fix" the housing mess is to have Fannie and Freddie write 125% loan to value mortgages.

    Previous articles here in the fool dealt with an underwater mortgage as the primary reason for default. I see no logical reason to think just because Obama sanctioned it, the outcome will be any different.

    In other words, the stocks of Fannie and Freddie are going to be (in fact already are) worthless and they will never be able to pay back the infusions of capital they are receiving from the government.

  • Report this Comment On July 30, 2009, at 7:52 PM, LessGovernment wrote:

    dudemonkey asks a good question.

    How do you value a bank?

    With off balance sheet assets not being marked to market, you can't. Part of the problem we have in our markets now is the fact that accounting has never been worse. Public accounting firms not only sanction, but recommend off balance sheet assets. When the P&L is based on the assets and liabilities that are on the balance sheet, it is simply impossible to have an accurate P&L with off balance sheet assets hiding write downs. Until that is fixed, all you can do is play the game of the greater fool. Buy a stock, any stock and hope someone else will pay more for it. If they do, you win. If they don't, you lose.

  • Report this Comment On July 30, 2009, at 9:26 PM, JibJabs wrote:

    Let me suggest MTB. Worth looking into.

  • Report this Comment On July 31, 2009, at 12:37 AM, barbarosssa25 wrote:

    what about citi? I kinda think it will get back to ten bucks some day any thoughts?

  • Report this Comment On July 31, 2009, at 12:40 AM, JakilaTheHun wrote:

    Good discussion. I do largely agree with Morgan Housel on banks. I think it's impossible for individual investors to be very knowledgeable with most of them and the heavy leverage creates a very low margin for error.

    I would say my views on banks are mixed at this point. I still think there are good buys, but I think any investor has to realize that this sector is more of a gamble than most. You can do some due diligence, but you're never going to uncover a lot of stuff no matter how well you know these banks (especially the large banks like BAC and C).

    That said, I like SunTrust (STI) the most of the national/semi-national banks. Their leverage is manageable, they have a good brand, strong customer base (similar to Wachovia in that regard), and I believe the stock is still undervalued at $19.

    As far as growth banks, I think CapitalSource (CSE) is worth taking a look at.

    However, I will say that in general, I'd rather play insurers than the banks. Many of them are more beaten down than the banks at this point and even if many of them have heavy leverage, they have safer assets on their balance sheets in most cases.

    I'd look at Progressive (PGR) --- strong company, great reputation, profitable history, good brand name; I'd consider them second to only Geico (BRK.B) in the industry.

    Chubb Group (CB) and Lincoln Financial (LNC) are also worth looks.

  • Report this Comment On July 31, 2009, at 12:55 AM, JakilaTheHun wrote:

    Also, great point by Dudemonkey. I've asked myself the same question dozens of times. Over the past year, I feel like I've had a great deal of success learning to value companies in a lot of different industries, but banking has been one nut I've never been able to crack.

    I think you have to be very knowledgeable to be a successful bank investor over a long-term timeframe. I've made some good calls in the sector (BAC @ 3.30, STI @ 7, CSE @ 2), but even my good calls have been about 30% analysis and 70% speculation. In reality, I don't know that there's any human being on Earth who could create an accurate valuation for a company like BAC.

    (Note that I've also made some really bad calls in the sector like CRBC. I think a few months ago, banks were beaten down so much that you could afford to make those bad calls and the good ones would offset them. I'm not so sure that's the case any more, which is why I'm more cautious on banks now.)

  • Report this Comment On August 02, 2009, at 10:29 PM, HROLLER30 wrote:
  • Report this Comment On August 05, 2009, at 12:14 PM, Mr5StarFool wrote:

    When the entities managing money in our economy have been allowed to morph into sufficient size and complexity so as to effectively avoid any further regulatory absolutes by which the myriad of arbitrary financial decisions and corresponding activities are constrained, an extremely dangerous scenario occurs: The system itself becomes absolute.

    Unless there arises a sufficiently strong arm with a two edged sword, the power and political will to do whatever it takes, (unfettered by the existing great forces of "free" market, blinded democratic tradition replete with stalling walls of habitual grandstanding congressional rhetoric, corporate lobbying, loyalties, litigation, lies and the like), we will witness an arbitrary nation of bankrupt citizens and institutions that no regulatory authority on earth can manage.

  • Report this Comment On August 05, 2009, at 12:31 PM, Mr5StarFool wrote:

    When the entities managing money in our economy have been allowed to morph into sufficient size and complexity so as to effectively avoid any further regulatory absolutes by which the myriad of arbitrary financial decisions and corresponding activities are constrained, an extremely dangerous scenario occurs: The system itself becomes absolute.

    Unless there arises a sufficiently strong arm with a two edged sword, the power and political will to do whatever it takes, (unfettered by the existing great forces of "free" market, blinded democratic tradition replete with stalling walls of habitual grandstanding congressional rhetoric, corporate lobbying, loyalties, litigation, lies and the like), we will witness an arbitrary nation of bankrupt citizens and institutions that no regulatory authority on earth can manage.

  • Report this Comment On August 05, 2009, at 12:58 PM, candacegeyer wrote:

    I have done extraordinarily well with Goldman, buying it when it was at its lowest. I just do not know when to sell or if I should sell. Any ideas?

  • Report this Comment On August 05, 2009, at 1:24 PM, slpmn wrote:

    How is your situation different than sitting at the blackjack table up big on the house, trying to figure out if you should cut and run? That's the line between investing and gambling. The investors are trying to figure out how to value the banks, and the gamblers are just wondering if their luck is about to run out. To the latter - if it doesn't shortly, it will soon enough.

  • Report this Comment On August 05, 2009, at 5:59 PM, mikecart1 wrote:

    I was shocked at this article.

    It actually was useful to read.

    More of these and less of those.

  • Report this Comment On August 06, 2009, at 6:07 PM, isaquejr wrote:

    Next financial behemoth: Santander and/or BBVA

    Next big failure: Citigroup and/or Bank of America

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