By Philip van Doorn, MarketWatch
MarketWatch photo illustration/iStockphoto
With the U.S. economy set to contract severely this quarter amid the COVID-19 lockdown, bank stocks as a group have fallen much more than the broader market. But it isn’t too early for investors to think about opportunities in strong players with competitive advantages that may be overly discounted.
On April 7, David Konrad, a managing director and analyst at D.A. Davidson, and Ian Lapey, a portfolio manager at Gabelli, discussed in interviews seven bank stocks that may turn out to be good investments.
You are probably familiar with this famous quote from Berkshire Hathaway /zigman2/quotes/200060694/composite BRK.B +0.69% CEO Warren Buffett, but a reminder is in order: “You want to be greedy when others are fearful. You want to be fearful when others are greedy.”
It sounds simple, but human nature makes it difficult for most investors to consider buying stocks during a time of panic. Buffett said that during an interview in October 2008 , and went on to make a lot of money from his timely investments in Goldman Sachs /zigman2/quotes/209237603/composite GS +2.82% in September 2008 and Bank of America /zigman2/quotes/200894270/composite BAC +3.16% in September 2011. Berkshire’s money was important to both companies when the investments were made, and Buffett’s scored lucrative returns.
Berkshire is now Bank of America’s largest stockholder, with 10.6% of common share outstanding, while it is Goldman’s fourth-largest shareholder, with a 3.5% stake, according to FactSet.
The seven banks
Analysts expect the largest U.S. banks to remain profitable on a full-year basis in 2020 and 2021. However, this is the point in an economic downturn when lenders must increase their quarterly provisions for loan loss reserves by large amounts, and all of that comes out of earnings.
When banks’ earnings are predictable, they can be valued on a price-to-earnings basis. But during a period of economic turmoil, investors and analysts focus on price-to-tangible-book values. Here they are for the seven companies Konrad and Lapey discussed:
|Bank||Price/tangible book value - April 7||Price/tangible book value - Jan. 31||Share-price decline - Jan. 31 through April 7|
|J.P. Morgan Chase & Co.||1.5||2.2||-32%|
|Bank of America Corp.||1.1||1.7||-35%|
|CIT Group Inc.||0.4||0.8||-62%|
|Bank of New York Mellon Corp.||1.8||2.3||-21%|
|State Street Corp.||1.7||2.3||-27%|
You may have to scroll the table to see all the data.
The price-to-tangible-book valuations have declined for all except for CIT Group /zigman2/quotes/200594362/composite CIT +5.63% . To put the share-price declines since Jan. 31 into perspective, the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.45% fell 18% during the same period.
Price-to-tangible-book valuations are usually higher for the two trust/custody giants, Bank of New York Mellon /zigman2/quotes/200171276/composite BK +1.42% and State Street /zigman2/quotes/209758976/composite STT +1.61% , because both have relatively low exposure to loan losses. Loans made up 14% of Bank of New York Mellon’s total assets as of Dec. 31, while loans comprised 11% of State Street’s assets.
The ‘safest’ bet
Lapey, who manages the Gabelli Global Financial Services Fund /zigman2/quotes/205810611/realtime GFSIX +1.20% , called Bank of New York Mellon and State Street the “safest” bank stocks to buy now, because “they are really asset managers and custodians, rather than banks.” Even through the Federal Reserve’s “ severely adverse scenario ,” used for the regulator’s stress tests of the largest U.S. banks in June 2019, both companies ”were actually profitable,” he said.
The Fed’s severe scenario included U.S. unemployment reaching 10%, a 50% decline for stocks and an 8% GDP contraction.
“They are the plumbing of the financial system, and so far it has worked well” through the coronavirus downturn, Lapey said.