Building Your Banking Portfolio
Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Let's review my favorite American banking stock and two Spanish banks. I believe one big and correctly managed US bank, and one of the two stocks I am about to present will give international banking exposure and reasonable yield to your portfolio. By the way, I did not pick Spanish banks only because they seem undervalued - US banks also seemed undervalued in 2008. And yes, I do know that Spain is in the middle of a huge crisis with unemployment at 25% with its GDP expected to contract by 1.3% in 2013. However, these two banks are not only European, but are also international institutions; they just happen to have their headquarters in Madrid.
Bank Of America (NYSE: BAC) is the bank to have in your portfolio because management knows where they are headed, and they are positioned to benefit from the US recovery. BAC is focused on increasing its Tier 1 capital ratio (today at 8.97%, it improved 102 bps quarter over quarter) and normalizing all its business lines: credit quality is getting better, mortgage banking is doing better than expected, and most settlement costs have been absorbed.
Next year shall be a key for BAC, and it currently trades at 70% price to tangible book value. According to the best analysts, the bank should go to 8x P/E from current 13x P/E and the current ROE of 3.69% will increase to 5.82%. Estimations were updated after BAC beat Q3 expectations. While analysts expected a loss, net income beat expectations and came in at $340 million. Results demonstrated progress and effort that is being made towards expense control. Things are getting better for BAC, and I bet the current 0.42% dividend will be increased many times in the next four years.
Banco Bilbao Viscaya (NYSE: BBVA) had to absorb all the real estate impairments due to new regulations, although in Q3 profits came in at $188 million, in line with consensus. BBVA is showing strict expense control and core capital remains at a healthy 10.76%. With new regulations in place, current P/E stands at 24x, but by 2013, P/E should go back to 9.5x. Meanwhile, until fear dissipates, you can take advantage of the 6.7% dividend yield. Even if the stock remains trading at 1.1x tangible book and underlying Spanish asset quality is still deteriorating, the bank has ample exposure to healthier geographies like Mexico, South America, and Turkey. Besides, as soon as Europe stabilizes this stock is poised to soar.
Banco Santander (NYSE: SAN) is one of the biggest and most efficiently managed European Banking institutions, although the lion's share of its profits come from Latin America, specifically Brazil, where Santander is a top five bank. SAN is also converting itself into a main UK institution through acquisitions, and last quarter made 20% of its profits there. Unfortunately, SAN had to book a $2.8 billion extraordinary provision to absorb the impact of new Spanish regulation and that's why it's now trading at 18x P/E. For next year analysts expect an already normalized 9.6x P/E and a 8.4% ROE (from 4.4% this year). Even if the bank could seem expensive trading at 1.3x Tangible Book, it has a lot of room to grow when Spanish losses are fully absorbed. By now, you can cash the 10.4% dividend that is expected for 2013 while investing in a well capitalized bank with a 10.5% core capital ratio.
You can build a banking portfolio with ample upside and a growing dividend yield by mixing BAC with either BBVA or SAN. I would go for SAN even if it looks more expensive. I could sleep better, and I would cash in a higher cash yield while I wait for BAC to return to a normal payout ratio. I feel the time has come to own some banking stocks. I recommend going to my blog, Warrentrades, to take some banking Fixed Income ideas!
martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!