The banking sector has certainly come a long way since the financial crisis. Banks are better capitalized, have less risky loans and other assets, and are taking steps to operate more efficiently. There are some good investment opportunities in the banking sector, and here are three of our contributors' favorites.
It's one of those rare banks that's consistently posted a profit, even in the thick of the financial crisis. The company's most recently reported quarter was typically strong – it netted almost $287 million in profit, on revenue of $1.2 billion. Both figures were higher than the consensus analyst estimates.
The long-brewing acquisition of Hudson City Bancorp will boost its presence in the always-valuable New York metropolitan area.
That deal took over three years to clear, as the Fed mandated M&T Bank tighten its money-laundering controls to its satisfaction. This was not a quick or cheap project to undertake. Meanwhile, the company recently admitted it is the subject of a Federal investigation into compliance with certain mortgage underwriting guidelines.
Those were uninspiring developments, and they've helped hold down the price of the stock. But since the bank at its core is a very smartly managed, efficient lender, it will get past these speed bumps. And its stock, I firmly believe, will rise accordingly.
Texas is an exceptionally difficult place to run a bank. Frequent boom and bust cycles in oil have destroyed a number of Texan banks over the years, but Cullen/Frost has used the volatility to its advantage. Its customers trust it with their deposits, which is best reflected in the fact that 40% of its deposit funding is non-interest-bearing. Texans know it's better to be able to sleep at night than risk their deposits for a little extra interest.
The market has reason to worry about Cullen/Frost's energy exposure given the decline in oil prices. Roughly 16% of its loans are to energy companies, a fact not lost on conservative bank investors. But that's only half the story. Loans to energy companies make up just 6.4% of its total assets as of June 30, which is a better measure of its exposure. Securities -- think safer corporate and government bonds -- make up about 45% of its portfolio. As a general rule, banks that forego higher-yielding loans for securities are typically less risky; it's a clear sign they're willing to let some incremental profits pass by in exchange for a lower-risk business model. (We'll know more about its energy risks when the banking industry resets borrowing bases for energy companies over the next few months.)
Make no mistake about it, though, Cullen/Frost's allocation to securities isn't punishing it on the income statement. Thanks to its efficiency and low-cost deposit funding, it generated a rather impressive return on tangible equity of roughly 14% in the most recent quarter. If rates rise, it'll earn even more. And if the oil cycle proves devastating to competing Texas banks, I tend to think it'll result in Cullen/Frost coming out of the downturn in a better competitive position. With just 3% market share of Texas deposits, there's plenty of room for this bank to grow by picking off the best customers from shakier institutions.
The bank is doing a better job of using its assets to produce profits, with a 0.99% ROA during the second quarter (just shy of the bank's 1% goal), and the crisis-era legal claims against the bank have dropped dramatically. In fact, a recent decision is producing $7.6 billion in reduced legal expenses for the bank.
Additionally, Bank of America's efficiency ratio (a measure of how much a bank spends to make its money) has steadily improved from 84% to 62%. The bank's return on equity of 8.4% isn't quite at its pre-crisis levels which were around 15%, but are certainly better than the 3.4% it managed in the second quarter of last year.
Finally, although Bank of America has improved tremendously over the past several years, its share price doesn't reflect that fact. Since the beginning of 2014, Bank of America stock is actually down by 2.5% despite all of the improvements I've mentioned. Shares still trade at a 28% discount to book value, and I'll be watching closely when the bank reports earnings on October 14 to see if the 1% ROA target was finally achieved and if the bank's cost cutting efforts are continuing to produce results.
Eric Volkman has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. Matthew Frankel owns shares of Bank of America. The Motley Fool recommends Bank of America. 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.