As we approach the end of a tumultuous 2011, it's time to look back on the year that was.
Few, if any, industries had a worse 2011 than the big banks. Check out the carnage (and remember that the S&P 500 was basically flat after factoring in dividends).
Price-to-Tangible Book Value
|US Bancorp (NYSE: USB )||(2.1%)||2.4|
|Wells Fargo (NYSE: WFC )||(14.7%)||1.5|
|JPMorgan Chase (NYSE: JPM )||(23.2%)||1.0|
|Morgan Stanley (NYSE: MS )||(44.5%)||0.6|
|Citigroup (NYSE: C )||(44.9%)||0.5|
|Goldman Sachs (NYSE: GS )||(45.8%)||0.7|
|Bank of America (NYSE: BAC )||(60.8%)||0.4|
Source: S&P Capital IQ. Return includes dividends.
None of these seven largest U.S. banks is leaving 2011 unscathed. US Bancorp and Wells Fargo, the two least Wall Street-y banks, came closest.
To recap the news this year, pretty much every negative macroeconomic event batters the banking stocks because they're players in so much of the economy, both domestic and foreign:
- They're all still recovering from the housing-bubble burst. When we hear about subprime lending, liar loans, derivatives run amok, poor documentation, and the need for better regulation, it's largely this group.
- In August, the U.S. lost its AAA debt rating while Congress played politics instead of fixing the budget. If you look at the stock charts for these banks, you can see the effect of this added friction and uncertainty.
- European sovereign-debt problems become problems for U.S. banking stocks because (1) the global financial system is increasingly tied together and (2) investors are having a hard time determining exactly how much direct European exposure the largest banks have.
- To expand on that last point, the U.S. financial crisis highlighted how opaque bank balance sheets can be (and how much stuff banks can hide off the balance sheet). This forces investors to assume the worst.
On the plus side, all the banks except Bank of America have been able to profit off cheap interest rates (thanks to the Fed) and high trading volume. That's why you see some low P/E ratios in this group. But much of that profitability is fleeting, especially if regulations cramp their style.
But this is more a balance-sheet tale than an income-statement tale.
When you go down the table from best-performing to worst-performing, you see a rough order of the likelihood of exposure to shaky lending and derivatives. US Bank and Wells Fargo are mostly regular old banks. JPMorgan is a hybrid Main Street and Wall Street bank that weathered the crisis better than the remaining four largely because of the leadership of Jamie Dimon.
Bank of America and Citigroup are also hybrids, but they've been proving to be the weakest of the herd. Citi did it organically, while Bank of America had help with its Countrywide acquisition. You can see the fear in their tiny price-to-tangible-book values, both half what JPMorgan gets.
Meanwhile, Goldman and Morgan Stanley are the only two full-fledged Wall Street megabanks left.
I see value in this uncertainty. The market is definitely valuing these banks on fear. And a lot of it is justified. Investing in these banks (especially as you go down the list) takes a leap of faith that the balance sheets can't be that bad. It may even require some faith that the government would bail them out again without destroying common shareholders if need be.
Investing in the largest banks isn't for the faint of heart. Fortunately, there is an alternative if you like bank stocks. Smaller regional banks are generally a lot simpler. Like US Bank and Wells Fargo, they mostly stick to taking in deposits and lending. Smaller bank stocks are by no means easy to decipher, but they're a heck of a lot more transparent than the Wall Street banks.
If you're looking for a good smaller bank to consider, I wrote a free report called "The Stocks Only the Smartest Investors Are Buying." It details a regional bank with some of the best operating metrics I've ever seen. I invite you to take a free copy. Find out the name of the bank I believe Buffett would be interested in if he still had the financial flexibility to invest in small banks.