Banking is a sector many investors have lost faith in. However, it remains one of Warren Buffett's favorite industries, and there are several bank stocks in Berkshire Hathaway's (BRK.A -0.30%) (BRK.B -0.26%) stock portfolio, including one of its largest positions.
With the recent turmoil in the banking sector and recession fears putting pressure on virtually all bank stocks, now could be a smart time to take a look at some of Buffett's favorite companies in the financial sector. These three, in particular, look extremely attractive right now.
Buffett's favorite bank stock
It's no secret that Warren Buffett is a big fan of Bank of America (BAC -1.07%). Not only is it Berkshire's largest bank stock, but it's also the second-largest stock position of any kind in the conglomerate's portfolio. Berkshire owns more than one billion shares of Bank of America, a stake of just under 13%.
In the most recent quarter, Bank of America beat expectations on both earnings and revenue. The rising interest rate environment has provided a nice tailwind to the bank, as net interest income increased 25% year over year. And unlike some of its peers, Bank of America's noninterest income grew slightly, thanks to strong trading revenue.
Bank of America trades for about 5% below its book value despite these strong results. The biggest investor fear (in banking in general) is a rise in defaults, especially if a recession arrives. While Bank of America's net charge-off rate has certainly ticked higher in recent quarters, it remains well below pre-pandemic levels. In fact, the bank's provision for credit losses actually declined compared with the fourth quarter of 2022.
A regional bank investors shouldn't worry about
U.S. Bancorp (USB -1.49%) is a relatively small investment for Berkshire, with "only" $281 million worth of the bank's stock in the company's portfolio. But after the recent pressure on regional banks, U.S. Bank is down by nearly 30% in the past two months and is certainly worth a look.
Unlike Bank of America, U.S. Bank is almost a pure commercial bank, meaning it doesn't have significant investment banking operations. It has a well-deserved reputation for stellar management and asset quality, and its shares have historically traded for a premium to other bank stocks. And aside from a brief dip during the early stages of the COVID-19 pandemic, U.S. Bancorp is trading for its lowest price-to-book valuation since the financial crisis despite excellent business results.
While it is technically a regional bank, because its assets are greater than $250 billion ($682 billion as of March), U.S. Bank is considered a systemically important financial institution, or SIFI. Otherwise known as "too big to fail," SIFIs are subject to a much higher level of regulatory oversight, and the government has essentially guaranteed deposits are safe, regardless of FDIC insurance status. So although it's a regional bank, U.S. Bank could end up being a beneficiary of depositors' flight to "safer" institutions.
This beaten-down online bank is ridiculously cheap
Berkshire owns just under 10% of online-based Ally Financial (ALLY -1.56%), which primarily focuses on auto loans and high-yield deposit accounts but provides a full range of banking services. With Ally, the concern is not that depositors will flee the bank, as 91% of Ally's consumer deposits are FDIC insured. Rather, the concern is the focus on auto lending and fears that consumers could start having trouble paying their bills in an economic slowdown.
However, Ally's latest results show there isn't any cause for panic. The business is still highly profitable, and while delinquencies have ticked upward, they seem to have started to stabilize -- in fact, retail auto delinquencies actually declined sequentially in the first quarter. Its reserves are more than enough to cover its current charge-off rates by a wide margin, and with an average new auto loan interest rate of about 10.9% in the first quarter, there's plenty of profit margin in this business model.
Ally trades for the rock-bottom valuation of just 75% of its book value and 5.3 times forward earnings. It offers a well-covered 4.6% dividend yield at the current price and has a fantastic track record of buying back shares with excess capital.
Don't expect a smooth ride
While I'm quite confident that the worst of the banking crisis is behind us and that these three should be relatively immune to things like bank runs regardless, that doesn't mean they will go straight up from here. There are still recession fears and tremendous uncertainties when it comes to inflation and interest rates. In short, while I think all three of these will end up being excellent long-term investments, I also expect quite a roller coaster ride in the months to come. Invest accordingly.
