Banking Sector: What To Miss & What To Buy

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

Talking about the US economy, consumer confidence is at its 5 year high levels, the unemployment rate has dipped, consumer spending is on the rise and REITs are booming. To take advantage of the recovering economic scenario, I’d say investing in the banking sector would be a good idea. However the pain caused by the toxic mortgage backed securities back in 2008, is hard to forget.

In the movie Wallstreet, Gordon Gekko used to say, “Greed is Good,” but in my opinion, it is not so “Good” when a bank becomes greedy. CIFG filed a lawsuit against Goldman Sachs (NYSE: GS) for $275 million for misrepresenting the quality and location of 6000 mortgage backed securities. CIFG also went ahead to sue against Bank of America (NYSE: BAC) for fraud and breach of contracts. Banks run on people’s trust, and if a bank repeats the mistakes that cost the crash of 2008, people would prefer to stay away from it, both for banking and investing purposes.

US Bancorp (NYSE: USB) and Wells Fargo (NYSE: WFC) have belonged to the group of conservative banks, with slow yet steady rewards.  Both the banks make money the traditional way, by lending. US Bancorp’s quarterly net income stood at $1.47 billion, up by 16% and overall revenues increased by 6%. On the back of a booming housing sector, the bank’s mortgage revenues more than doubled.

Due to low interest rates, the margins of nearly every bank have taken a hit. Wells Fargo reported quarterly profits of $4.9 billion, which surged by 22% YoY. The bank received mortgage applications worth $188 billion, and 72% of the issued mortgages were refinancing applications. Overall the bank made $2.8 billion from its mortgage segment. The bank ended the quarter with an application pipeline worth $97 billion.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Debt/Equity</p> </td> </tr> <tr> <td> <p>Goldman Sachs</p> </td> <td> <p>602%</p> </td> </tr> <tr> <td> <p>Bank of America</p> </td> <td> <p>250%</p> </td> </tr> <tr> <td> <p>US Bancorp</p> </td> <td> <p>140%</p> </td> </tr> <tr> <td> <p>Wells Fargo</p> </td> <td> <p>118%</p> </td> </tr> <tr> <td> <p>Regions Financial</p> </td> <td> <p>55%</p> </td> </tr> </tbody> </table>

(Source: Finviz)

Though, the debt/equity levels of both, US Bancorp and Wells Fargo are above 100%, they are significantly lower than their more aggressive peers. In my opinion, investors looking to safely capitalize on the booming mortgage financing/lending should consider investing in US Bancorp and Wells Fargo.

YTD Shares of US Bancorp are up 17.11% and Wells Fargo up by 15%.

However Regions Financial (NYSE: RF) catches the attention. The shares of RF are 52.53% YTD and the company is not highly leveraged unlike its peers. Regions Financial has a good price/FCF ratio, enjoys a healthy net profit margin and the metrics indicate that the stock is still undervalued.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Forward P/E</p> </td> <td> <p>P/B</p> </td> <td> <p>P/FCF</p> </td> <td> <p>Net Profit Margin</p> </td> <td> <p>LT Debt/Equity</p> </td> </tr> <tr> <td> <p>Regions Financial</p> </td> <td> <p>8.69x</p> </td> <td> <p>0.63x</p> </td> <td> <p>4.59x</p> </td> <td> <p>15.20%</p> </td> <td> <p>42%</p> </td> </tr> </tbody> </table>

Regions Financial is not counted amongst the conservative banks, due to its continued provisions for loan losses and slow approach in getting rid of the toxic assets. However analysts believe that its loan portfolio is improving and Moody’s has placed the company on an upgrade watch. According to Moody’s, Regions Financial has been able to successfully reduce its exposure to risky assets over the last 18 months and that the company has strengthened its risk management infrastructure. On a quarterly basis, its interest expenses declined by 19% and earnings rose from $101 million to $301 million YoY. Provisions for loan losses shrank by $6 million and the EPS stood at $0.22 beating the street’s estimates by 10%.

The quarterly commercial and industrial loans stood at $9.7 billion and the consumer loans totaled to $3 billion, up 7% from last year’s quarter. Overall Regions Financial witnessed a 2% increase in its quarterly loan production.

In my opinion, only risk bearing investors should look to invest in RF as its NPAs are still above 7% which calls for caution. Though the company is shedding off its toxic assets and could very well be a turnaround play, but one must be aware that it involves a significant amount of risk. Conservative Investors, should look to invest in US Bancorp and Wells Fargo for their solid financial performance and good fundamentals to keep the good times rolling.


PiyushArora has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America and Wells Fargo & Company. Motley Fool newsletter services recommend Goldman Sachs Group and Wells Fargo & Company. 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!

blog comments powered by Disqus