I've long been bearish on bank stocks and financials – but something happened last week that made me rethink my position.
I was having lunch with Citigroup Inc. (NYSE: C) Chief Executive Officer Vikram Pandit, and he had some interesting points.
According to Mr. Pandit, providing money and financial services to business is still a pretty attractive undertaking on a global scale.
Of course, he was also quick to mention that top quality risk controls and much higher liquidity are absolute necessities.
"Banks need to realize they are in a new reality," he said.
He couldn't be more right.
I warned you back in August that bank stocks were headed for a "catastrophic decline," and that proved to be true.
Since that article's Aug. 17 publication, Bank of America Corp. (NYSE: BAC) has tumbled 12.7%, Goldman Sachs Group Inc. (NYSE: GS) fell 9.9%, JPMorgan Chase & Co. (NYSE: JPM) is down 5.5%, and Morgan Stanley (NYSE: MS) is down 2.1%.
In fact, the MSCI US Investable Financials index is down 12.6% on the year and has achieved a less-than-stellar return of -12.6% per annum over the last five years.
And it's not hard to see why.
Third-quarter bank earnings were mediocre at best, and some of the special protections offered to banks are being wound down. Additionally, banks are in popular odium and demonstrations against them are erupting in every major U.S. city. And the effects of increased regulation are yet to come fully into view.
Still, for the first time since the stock price "bounce" of 2009, bank stocks are beginning to look somewhat attractive and the time to start bottom fishing may be at hand.
Banks Worth Buying
For those few banks with genuine global networks, international banking remains on a growth curve as globalization intensifies and more emerging market companies diversify outside their own country and region. Domestically, retail banking remains a good business. Credit card losses are beginning to decline while spreads remain at record levels.
Consequently, there are very good bargain-buying opportunities at large.
Remember, though, that any investment should be made gradually over time, because while the chances of a repeat of 2008 are remote — at least in the United States — there is still a great deal of risk and uncertainty in the banking sector.
You should avoid banks with large exposures to problems of the past. That means staying away from Bank of America and Wells Fargo & Co. (NYSE: WFC). Both of these banks remain heavily exposed to West Coast real estate, and in BofA's case, to the mortgage-backed securities disaster, as well.
However, the following financial firms are worth looking at:
- JPMorgan Chase & Co.: JPMorgan survived 2008 better than any other house, since its CEO, Jamie Dimon, was both conservative and shrewd. The firm has an excellent international and corporate franchise, which should do well going forward, and its foray into investment banking through the purchase of Bear Stearns has been brought well under control. JPMorgan's weakness is investment banking, which caused third-quarter earnings to decline 33% from last year. Nevertheless, even based on those earnings, its price/earnings (P/E) ratio is only about 8-times and it sells at about 83% of net asset value.
- Citigroup Inc.: Citi nearly went bankrupt in 2008 but has done considerably better since then (though pre-2008 shareholders have lost 90% of their money). Active in more than 100 countries, Citi has the best international network of any U.S. bank. This is a major competitive advantage in emerging markets, with which only HSBC Holdings PLC (NYSE ADR: HSBC) and Standard and Chartered PLC can really compete.
Citi also has a good U.S. consumer franchise, especially in profitable credit cards, and has de-emphasized the riskier parts of investment banking. Third-quarter earnings were inflated by a silly accounting rule that says you book a profit when your bonds go down, but on an operating basis, Citi trades at about 9-times earnings. More interesting, it's selling at just 51% of book value. While about a third of that book value represents deferred tax assets, which only become valuable as the bank earns profits, that's still a great deal.
- PNC Financial Services (NYSE: PNC): PNC made the smartest deal of all in 2008, buying the Cleveland-based National City Bank for $5 billion in stock, and getting $6 billion in tax write-offs with the deal. National City had run into mortgage problems, but its operations were in the Midwest, not California, so there were far fewer bubble mortgages to weigh down its balance sheet. PNC's third-quarter earnings were slightly up on an operating basis, and it's currently selling at a P/E of 8 and at 86% of book value. If you want a bet on a regional consumer-oriented bank, PNC is the one to go for.
Of course, if you're really looking for an investment-worthy bank, you'd be better off looking outside of the United States. For instance, in today's issue of Money Morning Private Briefing, I discuss what's currently my favorite bank stock. It's selling at just 49% of its book value, at 5-times trailing earnings and 4.2-times forward earnings, and it's based in a fast-growing Asian economy.
If you're already a Private Briefing subscriber, then you have all the information you need. If not, you can sign up here to get access to this banking stock, as well as a cache of other major-league profit plays.
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