Good Reasons To Stick With Regional Banks

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

It is not hard in this day and age to find “experts” who favor regional banks to large banks. Come to think of it, so do I. Bank of America (NYSE: BAC) represents pretty much everything that is wrong with the big, money center banks, a group in which I include Citigroup (NYSE: C) and JPMorgan Chase (NYSE: JPM).

 

As I am sure nearly all of you recall, in the troughs of banking chaos in late 2008, Bank of America, purchased both Countrywide Financial, and brokerage house Merrill Lynch. In retrospect, it seems obvious that Bank of America not only bit off more than it could chew, it also misled shareholders in the process.

 

Contrast the purchase of Wachovia, done without government aid, by Wells Fargo, to Bank of America's fiasco in purchasing Countrywide Financial for $4 billion. In addition to the purchase price, without meaning to be exhaustive, it has paid (1) mortgage losses of about $15 billion from 2009 through 2011. It is impossible to know exactly what percentage of those losses came from the Countrywide portfolio, but odds are the majority of losses stemmed from those loans; (2) Countrywide paid somewhere near $90 million to settle claims against former Countrywide CEO Anthony Mozilo; (3) In June 2010 Bank of America agreed to pay $108 million to settle an FTC charge that Countrywide had overcharged its customers; (4) Bank of America paid a $600 million settlement in May, 2010 due to Countrywide's securities going south; (5) Bank of America paid $13 billion in January of this year to settle with private holders of mortgage backed securities that had been sold prior to the Countrywide purchase; (6) $16 billion in mortgage repurchases from the likes of Fannie Mae (FNMA), and that number is steadily increasing. That is just a small sampling as there are billions of dollars more in claims either outstanding or yet have not been made. 

Wells Fargo (NYSE: WFC) bought a nearly as distressed Wachovia in late 2008, and took a huge write off of $38 billion in the fourth quarter of that year to cover what it believed were the questionable elements of Wachovia's portfolio. Wells Fargo reported a sizable loss that quarter, but now Wachovia's assets are adding substantially to Wells Fargo profits. Wells Fargo has had post acquisition headaches with Wachovia for sure, such as its well-publicized, multi-billion dollar money laundering matter with Mexican drug cartels that cost Wells Fargo $110 million. But however embarrassing, that is a tiny penalty compared with the sum of what Countrywide has cost Bank of America.

At nearly the same time as Bank of America was buying Countrywide, it also bought the venerable Merrill Lynch investment bank and brokerage for a cool $50 billion, and with substantial government guarantees and an additional $20 billion of taxpayer support. It took very little time for commentators to focus on that acquisition, even more so than the Countrywide deal, as a “deal from hell.” In retrospect, it really has not been that bad as after a rocky start, the old units of Merrill Lynch's remains have returned billions in profits in recent years.

Now civil charges are being made that within a day of the shareholder vote on the Merrill Lynch purchase, Bank of America management knew that the information in the proxy materials painted a fantasy picture of Merrill Lynch being non-dilutive and would very soon be profitable. It knew that sizable new writedowns would be forthcoming, and hid that information from voting Bank of America shareholders. This civil litigation against Bank of America and its Board is a slam dunk.

In recent quarters, Bank of America's quarterly earnings report has been uniquely obtuse, filled with one-time adjustments and revaluations of assets. The reports portray a picture of a company working to manipulate its earnings to best please shareholders. Yet, no one really is expecting substantial earnings going forward from the company, and it is trading with a higher 5 year PEG than any other large bank at 1.54. There is virtually no chance for a dividend hike in the next 12 months, either.

About the only thing I do know from the bank's recent quarters is that there is no intent to grow its loan portfolio. Loans outstanding have fallen annually since 2008, and with Bank of America's announcement that it would no longer accept any third party originated mortgage loan, the huge mortgage increases that have helped fuel many banks' earnings is not a part of Bank of America's future. At some point, it is going to have to take some risk and make meaningful loans again. But when it does, it will also have to increase its loan reserves, a prospect it has not faced since 2009.

I do not agree with Citigroup's international focus, but I understand it. I wish JPMorgan did not rely so heavily on its investment banking arm, but I see an upside to it. In contrast, I do not see a defined strategy of how Bank of America is really going to dig itself out of this hole. Its stock price is under $7, and at just 42% of its tangible book value, shows that investors in general have little faith in great earnings growth. The many analysts following the company are predicting operating, or “BBTH” (Before Bad Things Happen) second quarter of 2012 earnings of $0.17 per share. Time will tell.

There are so many other financials with more certain earnings, less legal exposure, and real dividends to boot. I have discussed U.S. Bank (USB) and Wells Fargo in some detail, and both are profitable and growing banks. Any of the large Canadian banks have healthy balance sheets, high dividends, and defined growth prospects. They benefited by not suffering the same degree of housing crisis and credit crunch that defined domestic banks late last decade. My personal favorite now is Bank of Montreal (BMO).  And some of the smaller domestic regional banks, like Fifth Third (FITB), Key Bank (KEY) and PNC Financial (PNC) also have a lot going for them, and should be considered by many investors. 


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