The banking sector was hit the hardest during the last recession, so many investors are understandably hesitant to hold bank stocks in their portfolios. However, not all banks are risky. In fact, there are some very safe bank stocks with tremendous upside potential that should be just fine when the next recession strikes. Here are the three bank stocks that are best equipped to survive the next recession, according to our analysts.
On its income statement, Wells Fargo leads in noninterest income. The bank's fee income, which makes up roughly 50% of its revenue, covered 83% of its noninterest operating costs in 2014. This gives it an inherent margin of safety against any weakness in its loan book.
Additionally, the bank aggressively manages its risks. In just one recent example, Wells Fargo announced a plan to reduce its subprime auto lending, capping higher-risk loans at 10% of its auto lending originations. It was the first big bank to do so, and the industry took notice. Wells Fargo has earned a reputation for being a "canary in the coal mine," cutting and running from lending verticals at the first sign of elevated risks.
In the next downturn, Wells Fargo's diversified income streams and prudent underwriting should keep it toward the top of the pack -- it's one of just a handful of banks safe enough to own through thick and thin.
After six years of recovery from the financial crisis, banks aren't looking forward to the next recession, but they know it will eventually arrive. When it does, U.S. Bancorp (NYSE:USB) should be in solid shape to weather the storm with flying colors.
One of U.S. Bancorp's biggest assets is its heavy concentration in the Midwest. That region tends to have less dramatic economic swings than other areas of the country, and that gives U.S. Bancorp more stability than many of its peers. At the same time, though, U.S. Bancorp has enough exposure to higher-growth areas, such as the West Coast, to give it opportunities to participate fully in economic expansion for as long as it continues.
Further, U.S. Bancorp has always prepared itself to handle lean times. The bank's efficiency ratio is among the best in the nation, staying consistently in the 50% to 60% range, while most banks' ratios are at least 10 percentage points higher. That emphasis on minimizing operating expenses will give U.S. Bancorp more flexibility to secure business through competitive pricing while also letting it maximize profits during the good times preceding the next recession. The company has proven its business model by making money consistently even during the financial crisis, so U.S. Bancorp should pass through the next recession without major difficulty.
I agree with Jordan and Dan that Wells Fargo and U.S. Bancorp are well equipped to survive whatever the market throws their way. However, my personal preference is Toronto-Dominion Bank (NYSE:TD), known to most people simply as "TD Bank."
All three institutions on this list focus mainly on the consumer side of banking (not investment banking or trading). In fact, 90% of TD Bank's earnings result from its retail business, and it has systematically reduced its exposure to "risky" operations over the years. TD Bank has exceptional credit quality, and its credit losses have fallen even lower over time. The bank is one of the few in the world rated "Aa1" by Moody's.
TD has an exceptionally strong balance sheet, and 70% of its funds consist of low-cost personal and commercial deposits, while just 12% are made up of long-term debt. TD has been named the "Safest Bank in North America" by Global Finance magazine, as well as the "Best Big Bank" by Money magazine.
As a final thought, while past performance is no guarantee of future results, one excellent way to predict how these banks could fare in the next recession is to look at how they did in the last one. During 2008 and 2009, the overall financial sector lost nearly half of its value, but the chart below shows that all three of the stocks mentioned here handily outperformed -- the financial sector is represented by the Financial Select Sector SPDR ETF (NYSEMKT:XLF):
Dan Caplinger has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. Matthew Frankel owns shares of The Toronto-Dominion Bank (USA). The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.