Is It Time to Bet Big on Banks?

All this talk of a double-dip recession is making many investors nervous -- none more so than shareholders of large banks. Even the thought of a second wave of credit defaults and foreclosures has been enough to knock the sector’s legs out from under it.

A very valid case can be made for avoiding financials given the cloudy worldwide macroeconomic outlook, but then again, it’s not often that opportunities are seized by following the herd. Instead, there are clear buy signals being cast by U.S. and European banks that mean now could be the opportunity to cast out that fishing line and see what grabs on to the other end.

Don’t fight inflation
If you always remember that the market is forward-looking, you’ll be less apt to be disappointed over the long term. For banks, the Federal Reserve’s stance on keeping the federal funds lending rate at a historically low 0.25% through mid-2013 has been a boon to the bottom line. Banks are able to borrow at historically low rates, then turn around and profit from that money by issuing loans.

What would be foolish (with a small f) would be to assume that inflation will remain at relatively low levels forever, because history has shown us time and again that this isn’t the case. However, as variable loans reset years down the road, and new loans are issued at higher rates, what ill effects banks might feel from a tightening in loan generations from rising rates should be offset by higher net interest income as quantitative easing ends and a recovery has investors beginning to care more about fiscal than economic issues.

Don’t let one bad apple spoil the bunch
Not every bank is a bad apple, either. A personal holding of mine, Bank of America (NYSE: BAC  ) , is attempting to settle a lawsuit brought against it for $8.5 billion, which related to the misrepresentation of loans derived from Countrywide Financial (now a subsidiary of Bank of America), but as of right now that settlement is far from a sure thing. Does this mean all banks are soiled with toxic mortgages? No! Just because National Bank of Greece (NYSE: NBG  ) has 16% of its assets tied up in Greek debt, should all banks with Greek debt be avoided? Again, probably not!

Each bank has a drastically different balance sheet and situation, and as I noted just last month, most European banks, including Barclays (NYSE: BCS  ) , HSBC (NYSE: HBC  ) , and Lloyds Banking Group (NYSE: LYG  ) have very minimal exposure to the sovereign debt crisis.

Banking on book value
Historically speaking, banks are -- pardon the pun -- primed for long-term success. Following the adage that you buy banks at half of their book value and sell them at two times their book value has been relatively successful. Some banks are already there, including the previously mentioned Bank of America and its partner in chaos during the credit crisis, Citigroup (NYSE: C  ) . Both seem more than adequately capitalized and are trading at incredibly low forward earnings multiples of 5 and 6, respectively.

Even JPMorgan Chase (NYSE: JPM  ) , a large bank that has largely breezed through every crisis lately with flying colors and demolished earnings expectations, is valued around 80% of book value and 6 times forward earnings. This doesn’t even take into account that it is one of the few banks that has reinstated a healthy dividend at 2.8%.

Foolish roundup
While these aren’t screaming “buy me” signals, the value in banks is about as unbelievable as I’ve ever witnessed. In 2008, the credit crisis tainted many balance sheets, and it was difficult to determine what was really left when all was said and done. Now, with a little government persuasiveness, banks are considerably better capitalized than they were three years ago. It’s not a stretch to assume that in two to three years, margins will be expanding rapidly and bank earnings are going to soar through the roof. Now might be the right time to bet big on banks.

What’s your take on the banking sector? Share your thoughts in the comments section below and consider adding Bank of America, National Bank of Greece, Barclays, HSBC, Lloyds, Citigroup, and JPMorgan Chase to your watchlist.

Fool contributor Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong. The Motley Fool owns shares of Bank of America, Citigroup, JPMorgan Chase, and National Bank of Greece. 

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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 September 02, 2011, at 8:03 AM, dbtheonly wrote:

    Except, of course, with the fraud lawsuits, the "put-back" remedies sought, the difficulty of proving who owns what for foreclosures, and the uncertain value of real estate; it is impossible to state with accuracy what BAC's book value is.

    That said, I got into BAC at $6.75.

  • Report this Comment On September 02, 2011, at 1:44 PM, Duke5343 wrote:

    IRE is actually going to survive with a 16% injection by US investors plus the IRish are recovering faster than expected- great buy at $1.18 as is LYG- holding on them for long term hope they dont pull a 10 to 1 like Citi did,should of held Regions over Citi slicker s

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