Avoid These Banks in 2011

It's been a pretty good year for banks as a whole. Through yesterday, the KBW Bank Index has topped the S&P 500 by a reasonable margin even though it's taken a dip over the past week.

Looking at the individual stocks, Bank of America (NYSE: BAC  ) was dragged down more than most during "foreclosuregate," and it's lost more than 18% so far this year. Both JPMorgan Chase and Goldman Sachs have spent most of the year drifting and are currently slightly down. Wells Fargo (NYSE: WFC  ) tacked on a modest 10%, but, interestingly, the best performer so far this year among the biggest banks has been Citigroup (NYSE: C  ) with a sweet 39% gain. Go Uncle Sam!

But stock-picking isn't a backward-looking pursuit, so we want to know what's ahead for the banking sector in the year ahead. My fellow Fools and I have already covered where to look for the best banking buys in 2011, so let's turn to what areas of banking you're going to want to avoid in 2011.

Investment banking
To start with, I'm not crazy about investment banks as an investment in general. The reward system seems to be forever tilted in favor of insiders, with investors bearing much of the risk for a fraction of the rewards. At the same time, the biggest of the investment banks -- Goldman, Morgan Stanley, JPMorgan -- still have very opaque operations and are difficult to analyze.

Looking specifically to next year, as I noted in a recent look at the investment banking outlook, there are definite opportunities, overseas in particular, but there are also going to be some stiff headwinds. These headwinds will provide drag for the focused investment banking companies like Goldman and Morgan Stanley as well as the diversified banking houses like JPMorgan and Bank of America.

Meanwhile, the smaller IB shops like Lazard and Greenhill, which I find much more interesting from a business perspective, don't have terribly compelling valuations.

Knocking at death's door
The banking sector is improving, but it's not quite out of the woods. As such, there are still plenty of banks that are on very shaky ground. Earlier this year, we saw Wilmington Trust hastily agree to sell itself to M&T Bank (NYSE: MTB  ) at a significant discount. Flagstar Bancorp (NYSE: FBC  ) , meanwhile, came to market with a painfully dilutive capital raise to shore up its balance sheet.

So whether you're avoiding a fire-sale of the entire bank or a crippling dilution, you'll want to shy away from the banks with the worst vitals. What do these banks look like? They look a lot like Doral Financial (NYSE: DRL  ) and Hampton Roads Bankshares. Both banks are in the double digits in terms of nonperforming loans as a percentage of the total loan book, neither has taken overly conservative loss provisions, and neither has a particularly comforting capital base.

With plenty of banks out there that have stronger capital bases and credit trends moving in the right direction, I think investors are best served avoiding speculation on banks that aren't on a relatively clear path to recovery.

Mind the valuation
The banking sector got absolutely hammered during the financial crisis, and there were some legitimately solid banks that were trading at highly attractive prices. There were also some slightly lesser quality banks that were knocked down to truly absurd prices.

Investors as a group still seem to be pretty skeptical of the banking sector, but there has been significant recovery from the lowest levels of the downturn. Shares of some of my favorite banks -- US Bancorp (NYSE: USB  ) and M&T Bank among them -- are already trading at fairly lofty multiples. If investors continue to warm back up to the industry, the group with premium valuations will only increase. As a result, investors will need to be even more mindful in the coming year of what price they're paying for the banks they're buying.

More good than bad
In all, I think there are a lot of opportunities in the banking sector heading into next year. A big part of this reasoning is the investor skepticism that I noted above. By avoiding the three areas mentioned earlier -- investment banking, banks with severe balance sheet issues, and overvalued banks -- I think investors can sift through the banking universe to get to the most out of the industry in the year ahead.

My fellow Fools have ventured into the non-bank financial sector to find three picks that could pop due to the resurgence of the individual investor. Claim your free copy of the report and check out the picks.

The Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (3) | Recommend This Article (24)

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 December 17, 2010, at 3:57 PM, foolshand wrote:

    your really didn't say a whole lot about Avoid These Banks. most of the ones you mention i have never heard of. so with that in mind WHAT ABOUT THE ONE THAT MAKING US LOSE SO MUCH F ING MONEY, BANK OF AMERICA. TALK ABOUT THAT ONE, FOOL!

  • Report this Comment On December 17, 2010, at 7:18 PM, TMFKopp wrote:

    @foolshand

    There are plenty of people talking about B of A, so I'm sure you can go elsewhere to read plenty about it. For me, it's in a no-man's land, I'm not convinced it's an outstanding investment right now nor do I think investors should avoid it like the plague.

    "most of the ones you mention i have never heard of."

    In that case, I suggest you take a harder look at the banking sector. There are a lot of good opportunities in the sector right now, but if all that you're willing to look at are the banks that are constantly in the headlines then you're going to miss them.

    Matt

  • Report this Comment On December 20, 2010, at 2:17 PM, jrod87 wrote:

    FBP, UWBK My two favorit for 2011.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1404140, ~/Articles/ArticleHandler.aspx, 9/19/2014 3:59:00 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Advertisement