5 Bank Stocks That Look Ready For A Sharp Pullback

Includes: BAC, C, DB, GS, JPM
by: Vatalyst

The New York Times is reporting that the Federal Housing Finance Agency, which supervises Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC), will be suing a number of America’s biggest banks. So far the list includes Bank of America (NYSE:BAC), JP Morgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), and Deutsche Bank (NYSE:DB). We’ll talk about Citigroup (NYSE:C) too since it tends to swing wildly when this type of news is reported:

Bank of America Corporation – Maybe Warren Buffett doesn’t know everything. Shortly after making his $5 billion investment in BAC, the company is now being flanked by even more lawsuits. In fact, BAC stock was down over 8% on Friday. Essentially, the FHFA is claiming that Bank of America misrepresented the $6 billion worth of mortgage-backed securities it sold to Fannie Mae and Freddic Mac between late 2005 and late 2007. Prior to being bought by Bank of America, Countrywide and Merrill Lynch may have also broken federal law when they sold mortgage-backed securities to Fannie Mae and Freddic Mac. One way that Bank of America might try to ease its current problems is to issue a tracking stock for Merrill Lynch, similar to the way that General Motors (NYSE:GM) issued a tracking stock for Electronic Data Systems. Others think Merrill Lynch might be spun out altogether. Bank of America executives remain confident though, and CFO Bruce Thompson wrote in an internal memo Friday: “We’ve made tremendous progress in resolving mortgage- related legal claims… Now we have to simply let the judicial process work.” He also wrote, “There are many non-dilutive ways for us to get there,” referring to how the company can raise capital without issuing more common stock.

JPMorgan Chase & Co. may be on the hook for $33 billion. That includes sales made by the bank and as well as subsidiaries such as Washington Mutual. Considered by many to be the top dog in the banking industry, this news will surprise quite a few shareholders. Regardless, JPM has been seen a lot of insider buying lately. In the last month, 7 insider transactions worth over $6.8 million have taken place. On the other hand, JPMorgan Chase also faces legal troubles in New York state court from IKB and HSH Nordbank, which are both German financial companies. That lawsuit too alleges mishandling of mortgage-backed securities, and actions taken by Bear Stearns are also coming under scrutiny. Even fallout from the Bernie Madoff scam could affect JPMorgan Chase. Bloomberg reports that a $19 billion lawsuit filed against JPMorgan Chase is still ongoing. Some investors like JPM stock regardless, and that article points out the bank’s low forward price to earnings ratio and low price to book ratio. Note that after Friday’s action in which JPM was down over 4.5%, the bank is trading at a price to earnings ratio of 7.39 and dividend yield of 2.89%. That price to earnings ratio is lower than other big banks like Barclays (NYSE:BCS) and Citigroup.

The Goldman Sachs Group, Inc. – Like JPM, GS stock was down over 4.5% on Friday. The trouble for Goldman really started on Thursday though, when the Federal Reserve announced sanctions against the infamous investment bank. These sanctions come on the same day that Goldman sold the subsidiary prompting those regulations, Litton Loan Servicing. While many of these sanctions may simply amount to a slap on the wrist, Goldman will probably have to pay for some damages financially. On the other hand, the Federal Reserve’s order for Goldman to look into “a pattern of misconduct and negligence relating to deficient practices” may not have much meaning with Thursday’s sale of Litton. That transaction represents the end of Goldman’s mortgage servicing business. GS was also in the news Thursday for its agreement with New York State regulators to stop robo-signing. Again, it remains to be seen how these words will translate to a change in business practice. At least one firm is downgrading the stock – ISI noted that the company looks more like a Hold now with its updated revenue/earnings projections. There’s even been some bank versus bank fighting, as Goldman is now disagreeing with BoA’s recent $8.5 billion Countrywide settlement. Finally, dividend investors may be interested to know that GS’s dividend yield is currently 1.3%.

Deutsche Bank AG – With its greater focus on Europe, many investors may be surprised to find Deutsche Bank on this list. And yet, the company could be in trouble to the tune of $14.2 billion. Deutsche Bank has yet to comment on the accusation. DB is also facing problems related to the debt crisis in Europe, where it remains to be seen what the fiscal fate of countries like Greece will be. As noted here, the International Accounting Standards Board claims that many banks have not correctly written down the value of Greek debt that they hold. From a value perspective, DB is quite cheap looking at price to sales. That ratio is 0.83, compared to 1.39 for Citigroup, 1.08 for Commerzbank (OTCPK:CRZBY), and 1.49 for UBS. Other statistics, like operating margin and price to earnings ratio are about average. DB’s cash flows are also worth taking a look at: 14.804 billion euros came in during 2010 while $7.344 billion euros flowed out during the first half of 2011. The bank’s recent cash flows problems have centered on changes in working capital. Regardless, DB is still offering dividends – yield is 2.18% after Friday’s action in which the stock fell over 6%. Additionally, some investors think DB’s current price puts it in an area of technical support.

Citigroup, Inc. – As the day has progressed, allegations against Citigroup have come out as well. The company may be responsible for much less damage than other banks though – about $3.5 billion. Nonetheless, that news brought the stock down over 5%. With its beta of 2.65, Citigroup moves big when this type of wide-reaching news hits. And that wasn’t the only big news that C stock was reacting to. Another poor unemployment report has macroeconomic concerns growing even stronger. Not all the news for Citigroup is bad though as the company is selling its student loans to Discover Financial Services (NYSE:DFS). As a non-core asset, we think this sale will make Citigroup even stronger. On the other hand, Citigroup will suffer financially if the AT&T(NYSE:T) -T-Mobile deal doesn’t go through because it is one of the advisors on that transaction. And with the Department of Justice’s recent complaint regarding the deal, it seems very likely that the acquisition won’t happen. With a price to earnings ratio of 8.78, price/earnings to growth ratio of 0.58, and price to sales ratio of 1.39, Citigroup’s value metrics are about average. Operating margin is a bit weak though compared to HSBC (HBC) and JPMorgan Chase – that number is 20.41%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.