Think the banking industry in the US is foundering and another collapse a la 2008 is inevitable? Looking at dwindling valuations of mega-cap banks might serve notice that they are on a slippery slope. To be sure banks are perched on a consumer class that is up against the ropes: The middle class, battered by a trifecta of collapsed housing prices, yet another stock market swoon and the specter of a job market that might take more than a decade to heal, is not likely to be a growth market for large banks. The foundations of a healthy banking system ultimately rest on a healthy consumer class: one that buys houses, borrows for new and existing small businesses, invests in stocks and bonds, and trusts the banks with their hard earned money in savings and checking accounts.
This “balance sheet” recession all but guarantees it will take a significant amount of time for such activity to approach pre-recession levels, and to be sure, the landscape for lending and how banks and consumers approach the credit markets will be changed at least for a generation. But consumers are only part of the story. Corporate balance sheets are healthy last time I checked, and the large banks do plenty of business providing liquidity and capital to other large corporations. The fact that the Federal Reserve announced rates will stay low for a predictable period of time is a boon to the banks and to “would be” corporate borrowers.
That banks were allowed to recapitalize themselves on the backs of a taxpaying public that could achieve no such benefit is grist for moral argument and will be a sore point and subject of controversy for the ages. That citizens and their smarting small businesses who have been asked to pay for this recapitalization of the banks through tax dollars have been largely frozen out of credit markets while corporations have unmitigated access to liquidity also rightfully rings hollow in the eyes of the public. Nevertheless, a far more debilitating depression was likely avoided and the foundation for growth -- albeit halting and uneven growth -- is now in place. Those toxic assets that were shifted around during the darkest hours of 2008 and TARP are still a wild card in the eyes of analysts and the investing public. How reliable are estimates for loan loss provisions? Are reserves for litigation too conservative? Will regulators force banks to raise additional capital?
These and other questions swirl around in the minds of analysts trying to grapple with the complexity and interconnected nature of these large financial institutions. Such unknowns make valuing banks fiendishly difficult. Yet there is reason to think that the penalty of the unknown is masking the true value of assets that banks maintain. The maxim “buy the rumor, sell the news” may be appropriate in this case. Just look at the missives being bandied about between Henry Blodgett and Bank of America regarding bank of America’s capital ratios. Warren Buffett's recent $5 billion investment in Bank of America (BAC) seems to have injected a dose of legitimacy to the sector. Additionally, a Raymond James analyst (Anthony Polini) brings up a salient point:
No bank has ever failed because of capital ratios. Liquidity is the thing that kills you and Bank of America has more than $400 billion in cash and liquid assets- more than three times what it was in 2008 which was the last time we reached these price levels.
Seems to me the big banks are in a vastly different place than they were in 2008 but the markets aren’t giving much credit for this. Goldman Sachs (GS) and Morgan Stanley (MS) have been restructured as bank holding companies and have far more conservative profiles. Indeed, for all the mega-cap banks, liquidity ratios are far higher than at any time in recent history, yet this spate of fear and doubt are leading to markdowns across the board. The discounts are so pervasive that many banks are now trading below liquidation value, according to Rochdale Securities analyst Richard Bove:
Many banks are selling below their liquidation values, let alone their franchise values ... Many should be bought.
I couldn’t agree more with the above sentiment. As a value investor one has to love the opportunities in banking that have recently availed themselves. Now is the time to buy large banks. Below is a diverse list of the largest banks that merit a closer look:
Company Share Price Market Cap Forward PE Bank of America (BAC) $7.66 $77 Billion 5.14 CitiGroup (C) $29.72 $86 Billion 5.75 JP Morgan Chase (JPM) $35.66 $140 Billion 6.31 Wells Fargo (WFC) $24.66 $130
7.04 US Bank (USB) $22.32 $43 Billion 8.45 Barclays PLC (BCS) $10.32 $30 Billion 3.82 Goldman Sachs (GS) $109.28 $55 Billion 6.51 Morgan Stanley (MS) $16.87 $32 Billion 6.09 UBS (UBS) $13.83 $52 Billion 5.65
Disclosure: I am long C, BAC, MS.