Bank Stock Picks Still Cheap?

Submitted by George Putnam, III as part of our contributors program.

Bank Stock Picks Still Cheap?

Big bank stock picks were some of the biggest losers—both in terms of stock price and reputation—in the financial crisis of 2008-09. Many of them had to take handouts from the government in order to stay in business. Their stocks cratered, and after the crisis abated they found themselves the target of both increasing regulatory scrutiny and massive lawsuits. As a result, while many banks have seen their business improve, their stocks have generally lagged the broad stock market.

I believe that the bank stocks look quite attractive now for a number of reasons. The recovery in the economy in general and the real estate market in particular have significantly reduced non-performing loans at most banks. While the banks were initially very conservative in making new loans coming out of the financial crisis, lending standards are getting back to normal, resulting in healthy loan growth. Regulators are still restricting dividends and stock buybacks at many banks, which means that the banks are building up cash as their businesses improve, and that cash could be used to reward shareholders when the regulatory constraints are finally lifted. Moreover, when interest rates eventually rise, that will fatten the profit margins on the lending business. Despite all of these positives, bank stocks trade at an average price-to-earnings ratio of about 12 compared to 16 for the rest of the market. And price-to-book ratios are still quite low by historical standards.

While the banks do still face headwinds such as ongoing litigation, increased regulation and reduced trading profits, these have been so heavily trumpeted in the financial headlines that bank stock prices have over-reacted on the downside. As investors become aware that these negatives are more than outweighed by the good things going on, bank stocks should snap back nicely. I’ve identified three value stock picks here and detail an additional six in my most recent contrarian investing newsletter. I believe that these large banks represent a mix of money center and large regional banks with strong rebound potential.

Bank of America (BAC) is still seen by many as a poster child for the financial meltdown, mostly because it purchased a huge mortgage company and a huge investment bank at a very inopportune time. While the company remains the subject of negative headlines, there are signs that its various pieces, including the untimely purchases, may be beginning to hit on all cylinders again.

If Bank of America suffered the most reputational damage from the crisis, Citigroup (C) had to be a close second, and both are still suffering from more regulatory strictures than most of their peers. But with its massive global reach, Citi has huge potential, and the new management team appears to be taking many of the right steps to slim the bank down so that it can realize that potential.

Fifth Third Bancorp (FITB) is a large regional financial services company with a solid management team. The challenge for Fifth Third has been lackluster growth in its largest markets in Ohio, Michigan and Illinois. But with the economy gradually picking up steam, those markets should improve, and Fifth Third is also expanding in faster growing markets such as Florida and North Carolina. Meanwhile, the bank is implementing restructuring initiatives to improve margins. I lowered Fifth Third to hold in January, but upon further review am making it a buy again, up to 25.