The banking sector has struggled this year, largely due to the banking crisis in March, which led to the collapse of several U.S. banks and triggered a wide sell-off across the sector.
Banks will likely continue to face funding and earnings pressure throughout the year and are also likely to face stricter regulatory requirements going forward. But after the broad sell-off, a lot of bank stocks trade at really attractive valuations that I expect to materialize into much higher stock prices in the long term. Here are three bank stocks to buy in May.
1. Wells Fargo
Large bank Wells Fargo (WFC 2.74%) is actually only down about 5% this year, which is pretty good all things considered, and it's performing better than many other bank stocks. But that's because I believe the shares already traded at a relatively cheap valuation heading into this year.
Management has been working to improve the bank's expense base and has also been dealing with ongoing regulatory issues that have plagued the bank since its phony-accounts scandal came to light in 2016.
However, the biggest thing Wells Fargo has going for it right now is its strong regulatory capital position. The bank has a ton of excess capital and management does not seem worried about its regulatory capital requirements changing too much this year after annual stress testing. Wells Fargo repurchased $4 billion of its stock in the first quarter and executives told analysts and investors that they expect to buy back more stock as the year progresses. That was a markedly different tone from its peers.
There is also another big catalyst looming. Wells Fargo has been operating under an asset cap for five years that limits balance sheet growth, which is a key way banks make money. Whether it happens this year or in the coming years, the removal of the asset cap will unlock a lot of earnings power, and the bank already expects to deliver a 15% return on tangible common equity in the medium term.
2. Citigroup
Citigroup (C 1.41%) is another large "too big to fail" bank that I believe is attractive now, trading at just 55% of its tangible book value and with minimum downside.
The bank's returns have long lagged peers and Citigroup also must modernize its operations to get into compliance with regulators. But it has embarked on an ambitious, multiyear transformation plan that involves divesting its international consumer banking franchises and investing in higher-returning parts of the bank.
While this journey is not going to happen overnight, I do see a more immediate catalyst later this year when the bank potentially announces the sale of its international consumer and middle market operations in its Mexico division, Citibanamex. The sale is complex because Citigroup has to work closely with the Mexican government, but it will free up billions in capital and give executives more clarity on where the bank's regulatory capital levels need to be. Getting rid of international consumer franchises could also lower Citigroup's overall regulatory capital requirements.
I'm hopeful that management can announce a sale soon, get the clarity it needs on its capital position, and then begin buying back shares in the back half of the year, which would be very attractive anywhere around where the stock currently trades.
3. Citizens Financial Group
The super-regional bank Citizens Financial Group (CFG 3.31%) has long traded at the bottom of its peer group and now trades right around tangible book value. But the bank has made a lot of progress since spinning out from the Royal Bank of Scotland in 2015.
While I was disappointed to see management significantly lower its guidance for the full year, largely due to higher funding costs, the bank has a strong balance sheet with lots of excess capital. The leadership team did not invest heavily in securities during the pandemic and therefore did not sustain much in the form of unrealized bond losses. This prepares the bank well for upcoming regulatory capital changes.
I also think management can continue to build on the progress it has already made on the bank's deposit base, especially with more recent acquisitions the bank completed in the New York Metro market.
