Despite this past week's pullback, bank stocks have been on a nice run as of late, buoyed by the gradual reopening of state economies and people getting back to work. In the first week of June, leading up to the May unemployment report, the banking industry jumped about 18% -- well above the S&P 500 over those five days. The economy added 2.5 million jobs in May as many people returned to work, and the market has reacted positively. More Americans working puts less economic stress on the system and reduces the potential for loan defaults.
These macro developments are a positive for the beleaguered banking industry, which was among the hardest hit by the pandemic. It is also a positive for investors in that there remain a lot of great values left -- and now is a good time to take advantage of them. Here are three incredibly cheap bank stocks -- two of which are large holdings for Warren Buffett and Berkshire Hathaway, and one of which you'll be happy to meet.
Bank of America
Bank of America (BAC 3.57%) is a banking behemoth that is trading at a major discount. Even with this rally over the past couple of weeks, the stock price is still down almost 30% on the year as of Friday's close. It is currently trading at less than 90% its book value of $27.84 per share. For most of the past four months, it was trading well below that. Earnings were down 43% in the first quarter, but that was primarily because the bank set aside an additional $3.6 billion in reserves to cover expected loan losses.
While the potential for significant loan losses remains, the improving economic picture has eased the potential harshness. Revenue has been fairly strong, down just 1% in the quarter despite 0% benchmark interest rates placing a drag on net interest income. Bank of America's efficiency ratio -- which measures a bank's expenses in relation to revenue -- remained largely unchanged year over year at 58%. That is better than the industry average.
Bank of America is an excellent company that is well-run, well-diversified, and well capitalized, with a common equity tier 1 capital ratio (CET1) of 10.8% and $699 billion in liquidity sources -- an increase over the first quarter of last year. It is also No. 1 in deposit market share. As the industry goes through an expected period of consolidation, Bank of America will still be there on top of the mountain. At this valuation, trading at 10 times earnings, it is a great deal that will pay off for long-term investors.
Even though Buffett sold nearly half a million shares of U.S. Bancorp (USB 2.08%), he remains a big believer in the company. Why else would he own nearly 150 million shares? The most likely reason he pared down his position is because he was close to 10% ownership, which would mean additional regulations, as Berkshire would qualify as a bank holding company.
U.S. Bancorp has gotten beat up in this market, like most traditional consumer banks, down about 37% for the year after Friday's close. But this is a great time to buy one of the most efficient major banks. It is trading at about a 24% premium to its book value, which is the lowest it's been in years, and its price-to-earnings (P/E) ratio is less than 10, which is also low.
Meanwhile, U.S. Bancorp had a return on assets of 0.95% at the end of the first quarter -- better than Bank of America, Citigroup, and Wells Fargo. This is a key measure of bank profitability, as it measures net income produced by total assets. U.S. Bancorp may continue to sputter through this recession and period of low interest rates, but if you buy this stock now at this valuation, you won't regret it long-term.
While the other two banks are household names that Berkshire Hathaway counts among its largest holdings, you may not have ever heard of Hilltop Holdings (HTH 4.25%). If not, consider this your introduction to a great little bank. Hilltop Holdings is a Dallas-based financial holding company that runs PlainsCapital Bank, mortgage lender PrimeLending, and investment bank Hilltop Securities. It is in the process of divesting its insurance company, National Lloyds, to focus on its three core banking businesses while enhancing its already strong liquidity when the deal closes in the second quarter.
Hilltop is incredibly cheap and efficient. It had a sparkling 1.47% return on assets at the end of the first quarter, up from 1.21% in the first quarter of 2019, and as of Friday it had a P/E ratio of 7. In addition, its efficiency ratio actually went down in the first quarter to 55.5%, which means its overhead cost to generate revenue went down. With its fee-based mortgage lending and investment banking business, the company is well-diversified to handle the downturn, even though it's down 28% this year. At today's prices, Hilltop is a good value and a solid buy.