If you're like us, you've been following the financial sector very closely; as banks go, so goes the economy.

And if you're really like us, you're wondering whether all this rubbernecking can be turned into profit making. So we asked our banking analysts. Then we asked them to name names. Enjoy!

Are you bullish or bearish on finding value in the banking sector right now?

Morgan Housel: I'll admit that there's value somewhere in the banking sector, but I'm still keeping my distance.

Why? Because I sincerely question how effectively individual investors can perform due diligence on a bank, regardless of intelligence or focus. Crack open Merrill Lynch's 2005 annual report and see how much data you can find on its collateralized debt obligations (next to nothing.) Or check out AIG's (NYSE:AIG) 2005 annual report and see how much detail it goes into regarding credit default swaps (almost none). It's extremely difficult, if not impossible, for individual investors to ascertain what's lurking on a bank's balance sheet.

So until things like regulatory reform and disclosure are overhauled, I'll happily keep my distance. If that means foregoing what in hindsight turns out to be a 10-bagger, so be it. 

Alex Dumortier: Resolutely bullish! The fire sale prices of the March market low are no longer on display but the environment has improved as well and there is still a tremendous amount of uncertainty weighing on the banking sector. Investors continue to grapple with large unknowns: potential future loan losses and the steady state profitability of banks in a post-crisis world.

Among the ten sectors in the S&P 500, financial stocks display the second highest variability in terms of their price-to-book value multiples (after industrials) -- that spells opportunity.

Matt Koppenheffer: In short, I'm bullish. There is no doubt that banking will continue to be important to the U.S. economy and many of the major banks will be showing considerable profits a few years down the road. It's also not much of a stretch to say that banks are trading at lip-smacking multiples -- on a book value basis many banks like JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) are trading below their normal valuation ranges, while some of the more troubled banks like Bank of America (NYSE:BAC) are trading well below book value.

The catch though, is figuring out which banks are the best bets to have the fewest skeletons in their closets, and for that reason I would prefer to put a few eggs in my banking basket.

Anand Chokkavelu: There's a lot of opportunity in banking. Any time there's this much volatility, there's opportunity. Look at the 52-week ranges of three representative big banks:

  • Citigroup (NYSE:C) ($0.97-$23.50)
  • Wells Fargo ($7.80-$44.75)
  • Goldman Sachs (NYSE:GS) ($47.41-$186.83)

You're reading that correctly. At one point this past year, you could have paid one-fourth what someone else paid for Goldman Sachs stock. The spread gets bigger with Wells (around one-sixth) and utterly ridiculous with Citigroup (less than one-twentieth)!

Imagine me buying the same flat screen TV you did, but for $50 instead of $1,000 and you get a feel for the vagaries of Mr. Market.

So the opportunity is there. The questions you have to ask yourself: 1) are banks in your circle of competence, and 2) which banks are the best bets? For no. 2, I'll provide some help with my answer to the next question.

Name one bank that's interesting enough to research further and one that you wouldn't touch.

Morgan Housel: Well, I just admitted that I'm keeping my distance from banks, but I'll play along anyways.

Bank of New York Mellon has a very unique business model, and is too often lumped in with its failed peers. It's primarily a banker to other banks and institutional investors, rather than consumers and businesses. This kept it away from most of the boom-year insanity that's pummeling other banks. I think it's an intriguing model that could still do well in the years ahead. 

Those I wouldn't touch? They're not banks, and it seems obvious, but this is an important point to make: The odds that Freddie Mac or Fannie Mae (NYSE:FNM) will ever have one penny left over for common shareholders is as close to nil as it gets. Fannie's own annual report admits it stopped trying to turn a profit altogether. That shares are still listed on an exchange is a disservice to investors.

Alex Dumortier: As I noted in an article published earlier this week, paying a mere 2% premium to book value to own shares of JPMorgan Chase certainly looks intriguing. The bank is emerging as one of the winners of the present crisis and Jamie Dimon has shown he is arguably the most talented CEO of a large bank in the U.S.

Prior to this crisis, the last time the stock's price-to-book value was where it is now was in March 2003. Since then, the annualized total return on JPMorgan Chase shares has been 13.8% -- besting the S&P500 by more than 8.5 percentage points annually than over the same period.

As far as banks I wouldn't touch, I won't single one out, but I will recommend investors be extremely cautious when it comes to any bank with significant exposure to commercial real estate. The cycle of losses on related loans and securities is far from over; regional banks such as SunTrust Financial, Comerica and Zions Bancorp could face painful writedowns.

Matt Koppenheffer: Wells Fargo is probably at the top of my list in terms of the bigger banks. It was more conservative than most through the boom times and seems to have weathered the storm better. Of course, its valuation reflects that and so you can't expect the same kind of returns that you would from, say, a resurgent Citigroup.

And speaking of Citi, that's one of the banks that I'm least interested in. Before the crash it certainly was a huge bank, but I never considered it the best in any of its business lines -- and recent performance hasn't changed my opinion. The heavy government involvement with the bank probably concerns me more though, since Uncle Sam is more concerned with avoiding public outcry than in running a sound bank.

Anand Chokkavelu: Banks get more complex the bigger they get. Small community banks that take deposits and make loans aren't that hard to grasp. But banks with huge operations and huge derivative portfolios are very difficult to get comfortable with; once you get to full-blown investment banks like Goldman Sachs, you're valuing risk machines, not banks.

Unless you believe the Goldman conspiracy theories, I'd stay away from it and Morgan Stanley. They're simply too opaque.

For my pick for further research, I'll stick my neck out with a small upstate New York-based bank I bought on weakness a few weeks ago: Community Bank System. I ran across it researching an article I wrote a couple months ago. In their words, they are "free of exposure to subprime or other higher-risk mortgage products within our real estate and investment portfolios." They are heavily provisioned for any losses, have a higher than average net interest margin, and are roughly equally weighted among commercial, residential, and consumer loans. Let me know what you think after you've done your research.

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