After warming up to bank stocks in 2016 and 2017, investors turned cold on the industry in late 2018, selling off bank stocks in wholesale, fearing that interest rates were simply moving in the wrong direction for bank earnings. The good news? The recent sell-off punished all banks, good and bad, enabling investors to buy shares of well-run banks at prices not seen in more than a year.
Back to the basics
Jordan Wathen (Bank of America): The last year in bank stocks has made one thing very clear: Not all banks are created equal when it comes to their ability to court depositors, something that matters more now than it has at any point in the last decade. In recent months, all bank stocks have traded down, but among the hardest hit were banks that have no competitive advantage in attracting low-cost deposits. As rates rise, banks that don't have a real deposit franchise are forced to pay higher and higher rates, even though loan yields have barely budged.
Bank of America may very well be one of the best deposit gatherers in the business, capturing customers with features that go beyond the interest rates it pays on balances. Notably, the average rate it pays on deposits has increased very little, rising to just 0.55% in the third quarter of 2018, up from 0.30% a year earlier, despite four Fed rate hikes in between.
With the future for interest rates looking cloudier than it has in recent memory, Bank of America has "all-weather" appeal. Its income sources are roughly equally split between interest and noninterest businesses, and its low-cost deposit franchise enables it to earn large margins so long as interest rates are some amount greater than zero. Banks that aren't as good at bringing in low-cost deposits are forced to rely on a friendly yield curve to maintain their margins; Bank of America isn't one of them.
An incredible institution at a major discount
Matt Frankel, CFP (Goldman Sachs): As we head into earnings season, many bank stocks are still beaten down after the stock market's plunge late last year. One in particular that has been on the top of my watch list for a while is Goldman Sachs, which, even after a recent rally, trades for a 14% discount to book value.
To be clear, Goldman certainly has its issues. The main reason why the bank has been such an underperformer recently is the uncertainty related to the "1MDB" scandal, which could result in billions in liabilities for the company.
However, the markets seem to be pricing in a worst-case scenario here, so it looks like a strong buying opportunity. Plus, Goldman Sachs has tremendous potential to grow its consumer banking business -- throughout its history, Goldman has mainly focused on wealthy and institutional investors, and it's finally starting to embrace the "other 99%."
I'll certainly be keeping an eye on Goldman's earnings report this week, especially for any comments regarding the firm's legal issues, but I'll also be paying attention to the growth in the consumer business, trading revenue (which could be quite strong thanks to the volatile fourth quarter), and more. I've been thinking of adding Goldman to my portfolio for some time, and January may finally be the time to do it.
Get to know this under-the-radar bank
Dan Caplinger (First Republic): One bank stock that I recently learned about from Jordan is First Republic. It's not a name most investors associate with the top tier of the banking industry, but its addressable niche is an important one: serving wealthy individual and commercial clients in areas like New York, Los Angeles, Boston, and the Bay Area communities associated with Silicon Valley.
The benefits of focusing on high-net-worth customers are obvious: First Republic earns more on a per-customer basis from interest margin and fee income than a typical bank, so it can afford to provide the higher-end services that the wealthy demand. Moreover, with exacting credit standards, First Republic's loan losses tend to be far less than a bank whose clients include those in weaker financial condition -- especially when conditions make it harder for most people to repay what they owe.
Fears of a recession have caused most banks to see their shares lose ground lately. But with its high-end clients largely able to resist the financial pressures of economic downturns, First Republic offers some protection for conservative investors. Its defensive characteristics and the growth potential from serving the high-end market make for a powerful combination, and January's a good time to look closely at First Republic's prospects in the year to come.
Dan Caplinger has no position in any of the stocks mentioned. Jordan Wathen has no position in any of the stocks mentioned. Matthew Frankel, CFP owns shares of Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.