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Big Banks vs. Baby Banks: Which Would You Buy?

Motley Fool analyst Matt Koppenheffer sits down with Rick Engdahl for a side-of-desk interview about banks. Are they really that hard to understand? Can the big banks be trusted? Join us for a discussion that sheds some light on banks from Citigroup  (NYSE: C  ) to Wells Fargo, as well as some of the smaller players.

In this video segment, Matt discusses the factors affecting different types of banks, and why he thinks the time is ripe for investors to return to the sector.

A full transcript follows the video.

Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

Rick Engdahl: I know downstairs on the first floor we have an asset management team who runs The Motley Fool funds. They had their annual shareholder meeting a few weeks ago, and I was there, listening to them.

They talked about how they have a basket of "baby banks" that they liked to invest in; their point being that there's so much post-crisis... they weren't sure about some of the bigger banks, but they felt very good about some of the smaller banks out there.

I just wanted to get your take on big banks versus baby banks, in your basket.

Matt Koppenheffer: I'm certainly not going to contradict. There are guys far smarter than me who are working on the asset management side.

Rick: As smart.

Matt: Yeah, I appreciate the flattery.

In my view, it's not as much about big versus small, as it is about quality versus valuation. You can kind of find a good balance that leads to a good investment across a spectrum. When they're talking about baby banks, I don't know exactly how small they're thinking.

Rick: Small regionals, I believe.

Matt: OK. Unfortunately, I don't get a ton of time to look at ... in the U.S. banking business I wouldn't even say it's like a pyramid. You've got the big four up here -- Bank of America, JPMorgan, Citigroup, and Wells Fargo -- and then you've got a group of super-regionals that are actually a good deal smaller, but still very, very large -- U.S. Bancorp (NYSE: USB  ) , BB&T (NYSE: BBT  ) , SunTrust  (NYSE: STI  ) is probably up there -- those kind of banks.

Those are kind of a second tier, but then you've got a big, broad, giant group of much smaller banks. In terms of the U.S. versus global banking systems, we have a very broad, deep pool in terms of the number of banks that we have in this country.

If you look at Canada, if you look at a lot of the countries in Europe, it's a very different banking system. It's interesting that we're so focused on the "too big to fail," where when you look at a lot of other major economies, their banking system is basically just too big to fail, or close to just too big to fail.

Anyway, I think the same thing goes back to thinking about quality, thinking about management. I still think there are bargain prices out there for a lot of banks, but even if there aren't bargain prices, if you find the right bank, if you find the right management team, it's finding that fair price. Making sure you're not over-paying.

I'm sure you can find that with baby banks, with smaller banks. Personally, I think right now you can find that throughout the spectrum of sizes.

The big four, I see those pretty much as a no-brainer right now in terms of where we are in the cycle for the economy, in terms of where those valuations are -- because the valuations tend to cycle along with everything else.

One of the lazy bank investing rules is, you buy banks when, I think it's under 1.5 times book value, or maybe it's under 1.0 times book value. I would think about in that range, between 1.0 and 1.5 times book value. Then you sell when they're 2.0 or 2.5 times book value.

When you look at the big banks, in terms of their book value multiples, with the exception of Wells Fargo, which is admittedly a cut above the other three, I think, they're right in there. I think they'll get back to those higher multiples, and in the meantime, the economy is going to continue to improve, their businesses are going to continue to improve, so I think you can do really well with the big banks. I think you can do well with some of the mid-tier banks, and I think you can find some great smaller banks.

I think in general, broadly speaking, it's a sector that investors have been slow to come back to in the wake of the crisis. Understandably so, but I think it's leaving a lot of opportunity for investors right now, while other sectors in the economy are getting bid up, and I just don't think are nearly as attractive as the banking sector.

Rick: The big banks are going to be more susceptible to unpredictable global politics and economics. Is that correct to say?

Matt: Sure, some to a greater extent than the others.

One of the interesting things about the big banks is... as we're talking, I'm grouping them together. People tend to group them together, but they're very different businesses.

Wells Fargo, for example, is almost fully focused on the U.S. It is a U.S. bank and it serves U.S. clients and customers.

Citigroup is on the other end of the spectrum, geographically speaking. It's got branches and it's got locations and it's got major business throughout the world. It's almost more of a 50/50 split between what it's doing in the U.S. versus the rest of the world. It might be even less of a 50/50 split, in favor of the rest of the world.

Then Bank of America, kind of in between those two; more U.S.-focused, but has a lot of global business, particularly through Merrill Lynch, but also through legacy Bank of America investment banking operations. JPMorgan, kind of the same thing, but focused more on growing its global business.

Citigroup, definitely has itself lassoed to the rest of the world, particularly emerging markets. JPMorgan yes, a little bit less so. Bank of America, less so still, and then Wells Fargo not really, so you've got a spectrum of how the global economy is going to impact the banks.

Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

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

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 September 16, 2013, at 9:55 PM, fkskippy wrote:

    Citigroup had a 10-1 reverse split in 2008 of which they have never paid back their share holders. Also they dropped dividends to $0.01 per share and pay every quarter instead of every month. They are currently in multiple lawsuits due to this as they are making money hand over fist again and NOT repaying stock holders with better dividends and share spitting. Investing in big banks is VERY risky. Surely you have not forgotten what happened in 2008 which crashed the stock market due to their foolish home loans that not only back fired in their face, but brought the United States economy to its knees. Stay away from big bank stocks! There are lots of better stocks and places to invest your money.

  • Report this Comment On September 17, 2013, at 10:59 AM, wouter28 wrote:

    I like seeing this first comment. I get a little nervous that I am overpaying when I see a cheery consensus. The sentiment in the post is part of the reason we are seeing such low valuations despite the environment being much better. The big banks are all now well capitalized and able to withstand a significant economic shock. Additionally, the economy will likely improve over the next few years driving loan demand. With interest rates increasing, the banks will be able to make better margins on the loans. I think the economy is setup to do well over the next few years, largely driven by improvement in housing. The supply of houses is still very low and we need to make up for the lack of building over the last few years. This leads to higher prices (more confident home owners who may tap that equity to stimulate the economy further) and jobs for home builders and suppliers. This will trickle down to the rest of the economy. The future looks bright and this will benefit the banks and improve valuations over the next 5 years.

  • Report this Comment On September 17, 2013, at 1:04 PM, FooLawson wrote:

    Go Bulls!

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