The Best American Bank

Awais is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: This article has been amended to better describe its visuals. In addition, Bank of America's loan-to-deposit ratio has been updated.

U.S. banking regulation is highly fragmented, and is regulated by both the federal and state governments. All commercial banks taking on deposits are obligated to obtain Federal Deposit Insurance Corporation (FDIC) insurance. FDIC provides deposit insurance, which warrants the safety of deposits in member banks, up to $250,000 per depositor per bank since July, 2010. The FDIC also scrutinizes and oversees certain financial institutions for safety and financial soundness, executes certain consumer-protection functions, and administers banks in receiverships, i.e. insolvent banks.

Dodd–Frank Reform inflicts sizable costs

Since the Great Depression, The Dodd–Frank Wall Street Reform and Consumer Protection Act has been the most sweeping transformation to American financial regulation, affecting almost every facet of the nation's financial services industry. Banks are forced to bear the brunt of higher costs to comply with the law.  And that's during their persistent struggle to control costs while seeking to increase net interest spreads by building their loan portfolios.

<img alt="" src="http://g.fool.com/editorial/images/52232/1_large.png" />

Source: Banking sector in the United States

The U.S. banking sector has grown radically over the last five years, whereby the contribution of bank’s portion of assets in the U.S. economy grew from 43% in 2007 to 56% in 2012.

<img alt="" src="http://g.fool.com/editorial/images/52232/2_large.png" />

Source = GDP United States

Moody's recently modified the U.S. banking system outlook to stable, which had been negative since 2008, as the economy’s operating environment continues to recuperate, thereby reducing the downside risks to the banking sector.

GDP growth is projected in the range of 1.5% to 2.5% this year, complemented by an unemployment rate dropping towards 7%. This will help banks protect their balance sheets, and U.S. banks will be well-positioned to face any future economic downturn.

<img alt="" src="http://g.fool.com/editorial/images/52232/3_large.png" />

*Source: The Growth of the U.S. Banking System | Financing America's Economy

As the economy is expected to recover from the recessionary phase, it is likely that the U.S. banking sector will rise as well.

Company analysis

So now that we've covered the basics, the goal is to find a great investment.  To do this, I narrowed the search to three American banks.  Let's take a look a closer look at First Republic Bank (NYSE: FRC), Wells Fargo (NYSE: WFC) and Bank of America (NYSE: BAC).

<img alt="" src="http://g.fool.com/editorial/images/52232/bac_large.png" />

Source: Company SEC Filings, Form 10-K

The loan-to-deposit ratio, a bank's liquidity statistic, stayed slightly above 100% for First Republic Bank and Bank of America. Both banks are fully utilizing funds at hand, neither under nor over lending. However, Wells Fargo is playing it safe by lending less than deposits, so as to never fall short of funds.

Non-performing loans (NPLs) are either in default or close to default, with the odds of full recovery being substantially lower. First Republic Bank has been able to manage its non-performing loans with efficacy with the figure being less than 1% of total loans. However, Wells Fargo and Bank of America are lagging behind in risk management. First Republic Bank has been able to exercise effective risk management ahead of its opponents.

First Republic Bank has registered the highest Return on Equity (ROE), followed by Wells Fargo. Bank of America has a very weak ROE, owing to the drastic declivity in its interest and non-interest income.

Efficiency ratio analyzes the overhead structure, with the lowest being the most desirable. First Republic Bank is making considerably more than it's spending and is therefore on sound fiscal footing. However, Bank of America Corporation must spend the highest amount in order to make one dollar of income.

Book value per share, being the highest for Wells Fargo, puts its investors in a secure position as they would get a reasonable return if the bank was to hypothetically liquidate. Conversely, Bank of America Corporation has the smallest book value per share due to its plunging revenues and net income.

<img alt="" src="http://g.fool.com/editorial/images/52232/5_large.png" />

*Chart uses Total Capital vs. Tier 1 Capital

The Basel III has specified a minimum of 8.0% total capital to risk-weighted assets, a regulatory requirement that has to be followed by banks to remain in compliance.

All three banks are safely operating within this requirement, providing them with extra cushion to take on higher risk to generate higher return. The increasing ratio puts the bank in a safe mode to be able to absorb volatility, should any losses occur.

<img alt="" src="http://g.fool.com/editorial/images/52232/6_large.png" />

Source: First Republic Bank Financials

First Republic Bank's deposit office size is largest amongst all its peers in the marketplace which puts it in a lead position.  That basically means its doing a good job of using its assets effectively.

Future Prospects

To sum up, analysis supports the conclusion that First Republic Bank is a strong buy candidate.  Based on the numbers, Wells Fargo could be a second choice, while the risk adverse may steer clear of Bank of America.  Take a look for yourself--you might come to the same conclusion.

Wells Fargo's dedication to solid, conservative banking helped it vastly outperform its peers during the financial meltdown. Today, Wells is the same great bank as ever, but with its stock trading at a premium to the rest of the industry, is there still room to buy, or is it time to cash in your gains? To help figure out whether Wells Fargo is a buy today, The Fool invites you to download this premium research report from one of The Motley Fool's top banking analysts. Click here now for instant access to this in-depth take on Wells Fargo.


Awais Iqbal has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America and 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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