5 Out of 6 Warren Buffett Bank Stocks Are Underperforming the S&P 500 in 2023 -- Which Are the Best Buys Now?

Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) doesn't own quite as many bank stocks as it did in recent years. In addition to unwinding its once-massive stake in Wells Fargo (NYSE: WFC), Berkshire also sold shares of JPMorgan Chase (NYSE: JPM), U.S. Bancorp (NYSE: USB), Goldman Sachs (NYSE: GS), and other banks.

Even at Berkshire's 2023 shareholder meeting, Buffett and Vice Chairman Charlie Munger expressed reluctance to put too much money into bank stocks in the current environment. However, there are still some bank stocks in Berkshire's portfolio, including a couple of rather large investments and some that are relatively new additions.

Data source: Berkshire Hathaway 13-F filings. Parentheses indicate negative numbers.

For context, the S&P 500 has produced a total return of 14% in 2023 through Oct. 18. So, five of the six "Buffett bank stocks" are underperforming the market this year, and some by pretty wide margins.

Reasons for the poor performance

Clearly, Nu Holdings is an outlier here. It's also the one bank that has the least in common with the other five on the list. If you aren't familiar, Nu Holdings is the parent company of Brazilian fintech Nubank. It has been a big outperformer in 2023 as its market penetration, geographical expansion, and revenue growth have soared.

However, looking at the five U.S. bank stocks in Buffett's portfolio, all have underperformed the market. And this may seem counterintuitive. After all, aren't rising interest rates good for bank profitability?

While rising rates are certainly a positive factor for banks, and most of these are seeing much higher interest margins than they were a year ago, there are some big factors that are more than outweighing any positives.

For starters, we're starting to see loan defaults rise at a pretty fast pace. As one example, Bank of America's net charge-off ratio in the third quarter was 0.35%, compared with just 0.20% a year ago. The others on the list are in similar situations. There are widespread fears that if the economy continues to worsen and inflation persists, consumers could have a tough time paying their bills, resulting in big loan losses for the banks. To be clear, there's no cause for alarm so far, as the higher NCO rates are consistent with pre-pandemic normal levels, but it's worth watching.

There are also lingering worries from the banking turbulence earlier this year. Now, all of Buffett's bank stocks are either in the "too big to fail" category or have high rates of FDIC-covered deposits, but some of the underlying issues certainly apply here. Many banks are sitting on billions in unrealized losses in their investment portfolios, for example.

Furthermore, many banks (including some of these) have significant exposure to commercial real estate -- specifically office properties -- in their loan portfolios. Many experts are calling for a crisis with these loans.

Which are the best buys now?

In a nutshell, Berkshire Hathaway's bank stocks have been beaten down primarily due to economic concerns, not necessarily for anything currently wrong with their businesses. Just to name a few examples, Bank of America beat expectations for both revenue and earnings this past quarter and grew its book value by 9%. Citigroup is making excellent progress on CEO Jane Fraser's turnaround and restructuring strategies.

The bottom line is that while these stocks are beaten down now, all of these Buffett banks are solid businesses that are in a good position to rebound when macroeconomic factors start to turn around. With several of the banks on this list trading for steep discounts to book value -- specifically Ally, Bank of America, Citigroup, and Capital One -- now could be a smart time for long-term investors to take a closer look.