The financial sector has been one of the worst-performing parts of the stock market in the COVID-19 pandemic. Since the beginning of February, the S&P 500 is down by just over 13% while the Financial Select Sector ETF (NYSEMKT:XLF) is down by 28% -- more than twice the drop in the broader market.
And to be fair, the current environment isn't great for banks. Record-low interest rates are likely to squeeze profit margins, and the recession could lead to a spike in loan defaults.
Having said that, there could be some excellent opportunities for patient investors with the risk tolerance to ride out the near-term ups and downs. Here's why U.S. Bancorp (NYSE:USB), Wells Fargo (NYSE:WFC), and Bank of America (NYSE:BAC) look particularly interesting right now.
Top quality assets at a low price
It's not everyday that you can buy U.S. Bancorp on sale. The bank typically trades at a steep premium to its book value, and for good reason -- it has a best-in-breed loan portfolio and has consistently been the most profitable of the big U.S. banks:
Because of its quality and profitability, U.S. Bancorp has rarely traded for much less than 1.8 times its book value in the past few years, but this premium has shrunk dramatically in current bear market. In fact, you'd have to go back to the depths of the financial crisis to find a time when U.S. Bancorp traded for less than the current 10% premium to book value.
With top-quality assets and a track record of responsible lending and investing during tough times, not to mention a dividend yield of more than 5%, U.S. Bancorp looks like a compelling bargain for long-term investors at the current price.
The most beaten-down big bank
Wells Fargo had been a massive underperformer before the COVID-19 pandemic. Because of its infamous fake-accounts scandal, numerous other "bad behavior" issues, and the unprecedented penalty placed on the bank by the Federal Reserve, Wells Fargo underperformed the financial sector by a staggering 33 percentage points for the three-year period from 2017 through the end of 2019.
This year has continued the trend. Wells Fargo has shed 50% of its value in 2020, making it one of the worst-performing banks during the COVID-19 pandemic.
However, it's starting to look like a compelling bargain. At just 68% of its book value, Wells Fargo hasn't been this cheap since the depths of the financial crisis. The bank is well-capitalized and has a relatively high asset quality. And new CEO Charles Scharf seems to be making the right moves to rebuild the public trust. With a rock-bottom valuation and a 7.6% dividend yield, Wells Fargo could finally be worth a closer look for long-term investors.
Incredible improvements and one silver lining
Bank of America is trading for less than 80% of its book value despite massive improvements in its business and impressive profitability in recent years (excluding the first quarter of 2020). In 2019, the bank posted 7% consumer loan growth and 5% deposit growth, both of which were among the best in the industry.
And despite the 2019 interest rate plunge, Bank of America generated a 11% return on equity (ROE) and 1.13% return on assets (ROA) in the fourth quarter of 2019, numbers that seemed unattainable for the bank just a few years prior. The bank's management team has done a fantastic job of using technology and other measures to dramatically improve efficiency and has improved its asset quality tremendously in the post-crisis years.
It's also important to mention that unlike the other two banks discussed here, Bank of America has a substantial investment banking operation, which can actually benefit from the current situation. In the first quarter, the industry posted some of its best numbers for trading revenue (volatility means more trading activity) and debt underwriting (companies are raising capital), and these could help offset the negative effects of the pandemic on the consumer side of the business.
What to expect from here
To be perfectly clear, I'm not attempting to call the bottom in these banks, and they could certainly go down further if the COVID-19 pandemic keeps the economy shut down for longer than expected, or if the resulting recession is deeper than experts predict. And even if we don't get any more devastating news, it's fair to expect quite a bit of volatility in these bank stocks as the coronavirus outbreak plays out.
The point is that these three bank stocks all look attractive from a long-term perspective. At some point, the economy will recover and stabilize. Interest rates will likely rise to a level where banks can be more profitable. And while we might see an uptick in defaults in the short term, it isn't likely to become a long-tailed problem. So, while I have no idea what these bank stocks will do next week, next month, or even later in 2020. But if you measure your investment returns in multi-year timeframes, now could be a good time to look at the banks.