"The Most Important Thing" About Bank Stocks

The Continental Illinois Bank Building in Chicago. Commonly referred to as the first too-big-to-fail bank, Continental Illinois was seized by the FDIC in 1984 after a fear of bad loans ignited a bank run. Source: Wikimedia Commons.

In 2003, Howard Marks, one of the world's most successful investors, wrote a memo to his clients titled "The Most Important Thing" (link opens PDF). He then proceeded to list 18 such factors, ranging from the avoidance of leverage to the necessity of a contrarian approach to investing. But ascending above the rest was, and remains, the relationship between price and value. It truly is the most important thing.

I thought about this recently when I read through a presentation that the chief executive officer of New York Community Bank (NYSE: NYCB  ) gave at this year's Barclays Global Financial Services Conference. Amidst the requisite self-congratulatory introduction, CEO Joseph Ficalora made two comments that were particularly notable.

He observed that NYCB's compounded annual growth rate since its initial public in 1993 is nearly 28%, equating to a total return of more than 3,400%. That's on par with the greatest businesses and money managers of our era. On top of this, he noted that the bank has had 52 consecutive quarters, "wherein we've had [zero] losses on the assets that we created."

This is astounding. Those 52 quarters include both the more recent financial crisis and the brief recession following the bursting of the dot-com bubble. Over the last five years alone, nearly 500 banks have been closed by the FDIC, and countless others have suffered debilitating losses that forced them to dramatically dilute their existing shareholders.

Indeed, the more representative examples are those of KeyCorp (NYSE: KEY  ) , Huntington Bancshares (NASDAQ: HBAN  ) , and Citigroup (NYSE: C  ) , which have lost 46%, 59%, and 69% of their book values, respectively, since the beginning of 2008.

How did NYCB avoid a similar fate? The answer is deceivingly simple. "When you think about what, in fact, distinguishes a bank as a lender," Ficalora said, "it's how much money it loses on the asset that it chooses to take risk with."

The corollary of this rule was articulated by Carl Webb, the second in command at Diamond A Ford, an exceptionally successful bank buyout firm founded by the billionaire Gerald J. Ford. "Banks get in trouble for one reason," Webb observed. "They make bad loans."

The most important thing for running a successful bank, in other words, is not originating bad loans.

That's it. It's not about hedging. It's not about creating a diversified business model with credit cards and investment banking units. It's not about making smart acquisitions. What matters is the quality of the assets that a bank originates and holds onto.

And lest there be any doubt, aside from NYCB, the most successful banks over the last few years have not been the universal banks like Citigroup and Bank of America (NYSE: BAC  ) , both of which have seen their respective stock prices decline by 73% and 55% over the last five years as a result of bad loans and imprudent acquisitions.

Instead, they've been the stodgy, old-time lenders like U.S. Bancorp that never abandoned their focus on the principal functions of banking, gathering deposits, and writing good loans.

Have you missed out on the massive gains in bank stocks like New York Community Bancorp in the past? There's good news: It's not too late. Bargains of a lifetime are still available, but you need to know where to look. The Motley Fool's new report "Finding the Next Bank Stock Home Run" will show you how and where to find these deals. It's completely free -- click here to get started.


Read/Post Comments (18) | Recommend This Article (31)

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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 11, 2013, at 5:11 PM, EvanBuck wrote:

    Thanks for the read, John. Would you recommend NYCB at this price?

  • Report this Comment On September 11, 2013, at 5:12 PM, EvanBuck wrote:

    Thanks for the read, John. Would you recommend NYCB at its current price?

  • Report this Comment On September 11, 2013, at 5:12 PM, EvanBuck wrote:

    Oops, sorry, the comment posted twice. >.<

  • Report this Comment On September 11, 2013, at 5:21 PM, collins444 wrote:

    If they had no losses on assets how did they lose $.48/share in Q2 2008?

  • Report this Comment On September 11, 2013, at 5:35 PM, JohnMaxfield37 wrote:

    <If they had no losses on assets how did they lose $.48/share in Q2 2008?>

    From NYCB's 2Q08 earnings release:

    "As previously disclosed by the Company, its second quarter 2008 GAAP earnings were impacted by the prepayment of $4.0 billion of wholesale and other borrowings . . . On a pre-tax basis, the debt repositioning charge was equivalent to $325.0 million, including $285.4 million that was recorded in non-interest expense and $39.6 million that was recorded in interest expense."

  • Report this Comment On September 11, 2013, at 5:36 PM, Seanickson wrote:

    Just as important is the quality of the liabilities. The best banks such as USB and WFC are successful because they keep deposit costs low and use very little long-term debt.

  • Report this Comment On September 11, 2013, at 7:05 PM, xetn wrote:

    The most important thing for banks (especially true of fractional-reserve banks, which is all banks today) is their capital. Most US banks only have roughly 2-3 %. Bank capital is basically cash on hand to deposits.

    If banks are well capitalized, and do not take undue risks, they can survive problems associated with loan losses. The major problems with banks today are the moral hazard associated with FDIC and taxpayer bailouts. These allow bankers to take unnecessary risks in the markets such as derivatives.

  • Report this Comment On September 11, 2013, at 7:16 PM, chris293 wrote:

    The FDIC should work closely with Congress to insure that laws and regulations restore trust and honesty in both institutions. For that to happen the media from newspapers, radio/TV, and the internet have to be open with the information and pass this on in clear simple language to the general public so we can understand what really is going on.

    Sadly, most of the people involved use fancy words to snow us and distort the truth.

    "Honesty is the best policy," Ben Franklin would be spinning in the hereafter if he knew what has happened to the banks, some even bearing his name. But that's past. Our opinions and votes really do count.

  • Report this Comment On September 11, 2013, at 7:52 PM, SanMateo100 wrote:

    Fascinating - I drew a chart (at Yahoo Finance) comparing NYCB vs S&P500 for last 5 years - sure looks like investing in the plain old S&P would have been a MUCH better choice - same for the Dow or NASDQ. So, I wonder if there is a point here other than to convince us to buy one of the (many....) MF newsletters?

  • Report this Comment On September 11, 2013, at 8:00 PM, Montereyjackson wrote:

    Points by John Maxfield are well taken. My two cents is that no bank could do what NY Community has done without an exceptional management team. John Allison, former CEO and chair of BB&T, has a good book out and what it takes to run a bank successfully. Mr. Allison's conservative, free-market views do take up a good bit of the book, but even if you don't agree with them, the parts on how BB&T grew without stumbling can serve us Fools well. I will be interested in looking at Joseph Ficalora's statements to his shareholders for the same reason.

  • Report this Comment On September 11, 2013, at 8:16 PM, hanover67 wrote:

    The fed has a model they use for regulating banks known as CAMEL, which stands for Capital, Asset quality, Management, Earnings, and Liabilities. But, they pronounce it C-C-C-C-C-AMEL, as Capital is their most required aspect. Walter Wriston used to say that the best form of capital was a strong stream of earnings.

    My former job used to involve taking credit risk against US banks, and to me, asset quality was the best indicator of the banks' future. I cooked up a formula that said when a bank's non-performing loans plus OREO reached 8% of total loans plus OREO, then 100% of its earnings would be gone.

    So, I agree that making bad loans is the best way for a bank to get into trouble, more so if those loans are to officers, directors, or other insiders.

  • Report this Comment On September 12, 2013, at 1:24 PM, dsciola wrote:

    "Fascinating - I drew a chart (at Yahoo Finance) comparing NYCB vs S&P500 for last 5 years - sure looks like investing in the plain old S&P would have been a MUCH better choice - same for the Dow or NASDQ."

    Good point SanMateo. Got me thinking also, and I think there's a few other factors at play.

    1 - banks altogether got hit uber hard post financial crisis...hence BAC, C, etc per John's piece above collapsing in share price...and even more once Obama got elected...I think one could make a case that a lot of that industry-risk dragged down NYCB, regardless of how well it did or may even not have done.

    2 - market has done exceptionally well...so u've got 'systemic' risk pushing stocks actually up as a whole, but 'industry' risk pushing down bank stocks

    Hence, one could argue no surprise NYCB is still lagging the S&P...possibly an apples-oranges comparison...

    So I think the next question to ask in context of this is if NYCB got unfairly punished due to the industry its in...which granted is a major assumption there that requires more DD...then will it rebound more than its banking peers / the S&P going forward?

    My 2c.

    Dom

  • Report this Comment On September 12, 2013, at 4:21 PM, SanMateo100 wrote:

    Dom,

    You might be right - I was more reacting to: "He observed that NYCB's compounded annual growth rate since its initial public in 1993 is nearly 28%, equating to a total return of more than 3,400%." which made it sound (to me at least) that we would have been winners had we invested in it. At the end he writes: "Want even more market-beating investment ideas?"

    So while it may be a solid (and undervalued) stock, it's history since 2008 does not suggest that investing in it would have been a "market-beating investment idea". And I am not sure there is any data to suggest that it's trajectory will change in the near future. Maybe I am attributing something to the article that I shouldn't have, or perhaps I am not reading it correctly?

    - Ed

  • Report this Comment On September 12, 2013, at 4:30 PM, dsciola wrote:

    I think that CAGR is referencing its book value...NOT its market value or stock price

    Care to clarify, John?

  • Report this Comment On September 12, 2013, at 4:35 PM, DBrown7 wrote:

    Did anyone notice the dividend yield? It's about 6.7%. The good news is NYCB didn't have to cut it during the financial crisis. On the other hand, the dividend hasn't been raised since 2004 and the payout ratio appears quite high. As others have already pointed out, the bank seems to have grown fairly slowly in recent years.

  • Report this Comment On September 13, 2013, at 5:04 PM, FriedBrain wrote:

    "Fascinating - I drew a chart (at Yahoo Finance) comparing NYCB vs S&P500 for last 5 years - sure looks like investing in the plain old S&P would have been a MUCH better choice - same for the Dow or NASDQ."

    SanMateo100 - your mistake is that you viewed a chart measuring the change in NYCB's share price, not its total return.

    Try accounting for the total return (price + reinvested dividends) on a share of NYCB to get a better picture of which is the better investment.

  • Report this Comment On September 14, 2013, at 12:46 PM, RxDan1 wrote:

    No, the most important thing to no about Bank stocks is if they are ethical: Were they one of the ones heavily involved in the great recession? Are they sitting on a ton of money and not loaning? Did they buy a broker and a loan maker that caused a good chunk of the trouble e.g. Bank of America? Are the CEO's that were responsible for our demise still running the show e.g. AIG and a lot of others. If there is a Yes to any of these questions, than don't invest. Those that do or recommend these bad guys should be ashamed.

  • Report this Comment On September 14, 2013, at 8:51 PM, IndianaLarry wrote:

    For my hard earned money, NYCB is not investment grade.

    I think the report by MF leads me into the wrong conclusion about the bank's actual performance.

    I like to rank changes in revenues, earnings per share, along with the current stock price as to whether it is a good buy at the time of evualuation.

    NYCB does not merit many of the qualitities I look for in a bank stock. They are a survivor and that tells us something. Good luck.

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