10 Undervalued Bank Stocks For The Long Haul

Submitted by The Turnaround Letter as part of our contributors program.

Banks seem to be the companies that everyone loves to hate these days. Many politicians and journalists are still bashing the banks for helping cause the financial meltdown in 2008. Those who have finally moved beyond 2008 are now criticizing the banks for a whole new panoply of sins such as being too restrictive in their lending policies, being too lenient in their lending policies, taking too many risks, not taking enough risks, etc. Politicians and journalists do not appear to be very concerned with being consistent.

For investors who have been brave (or contrarian) enough to venture into bank stocks, they have been quite rewarding. For example, Bank of America stock has quadrupled from its low in 2009, and since the end of 2011 it is up by 119%. Despite this type of gain, I believe that the bank stocks have a lot further to run. It probably won’t happen overnight, but if you are willing to buy and hold some bank stocks for several years, you should be handsomely rewarded.

There are a number of reasons why I like banks right now. First, they are cheap by historical measures. A number of banks today are still trading below book value; just a few years ago, many traded at two or three times book value. Second, loan growth (which, as long as the loans are made prudently, leads to profit growth) is likely to accelerate as the economy continues to improve and lending polices become a little more liberal. After 2008, many banks became ultra-conservative; in other words, closed the barn door after the cow was already out.

Another reason I like the banks is that they are generally faring well on the government’s “stress tests” (which are probably another example of closing the barn door too late, but that’s another story). This means that the banks are less risky than in the past. Moreover, after a bank passes its stress test, the government is likely to allow it to raise dividends and initiate stock buybacks–both of which should boost the stock price.

Finally, I think banks will benefit when interest rates eventually begin to rise. With rates held low by the Federal Reserve, lending margins have been compressed, which holds down profitability. As rates rise, margins should expand, leading to more profits. The banks discussed below are a mix of money center banks and regional banks that have strong business franchises and that I think could be particularly rewarding for investors.

Bank of America (BAC) was both a victim and beneficiary of the financial crisis. While it took big hits from an operating perspective, it was able to greatly expand its reach by buying Countrywide Financial and Merrill Lynch. Management has done a good job of realigning the asset base and bolstering the balance sheet. The Fed just approved its plan to buy back $5 billion of stock and $5.5 billion worth of preferred shares. Bank of America is benefiting from the revival in the housing market, and it has made significant headway in resolving mortgage-related litigation.

Citigroup (C) was in the infamous position of being the largest recipient of federal bailout money during the financial crisis; but it has come a long way–disposing of non-core businesses and shoring up its capital base. Following the latest stress test, Citi obtained Fed approval to repurchase up to $1.2 billion in stock and maintain the dividend. A new CEO took over last October, and management should soon be able to move beyond balance sheet repair to return to focusing on the company’s substantial international growth opportunities.

Fifth Third Bancorp (FITB) operates mostly in Ohio and Michigan but has a presence in ten other largely Midwestern states. Since the financial meltdown in 2008, the company has refocused its efforts on its core commercial lending business. After the latest round of stress tests, Fifth Third received approval of its plans to raise the dividend and increase its share repurchase program to $984 million. Fifth Third reported solid operating results for 2012 and ended the year with a lower level of nonperforming loans than many competitors.

JPMorgan Chase & Co. (JPM) has had more than its share of negative headlines recently. But despite its botched “whale trade” that led to a more than $6 billion trading loss, the company was still able to report a $21.3 billion profit for 2012. Notwithstanding the negative press, JPMorgan remains a global powerhouse. Although the company still has some issues to resolve with the Fed, I expect the company to get approval to increase the dividend and repurchase roughly $6 billion in stock over the course of the next twelve months.

PNC Financial Services Group (PNC) operates primarily in Pennsylvania, Ohio and New Jersey, but its reach extends into 19 Eastern states. During the financial crisis, PNC was able to expand its reach by buying National City, a struggling competitor. Management has received a green light from the Fed to raise the dividend, but share buybacks will probably be deferred in light of PNC’s recent acquisition of RBC Bank’s southeastern US assets. PNC currently owns about 21% of the investment company Blackrock (BLK), which is another valuable asset.

Regions Financial (RF) is focused on the Southeastern U.S. What a difference a year makes: last year Regions was selling its brokerage unit for $1.2 million and issuing common stock to raise another $900 million; this year, the company has received Fed approval to increase its dividend as well as buy back up to $350 million in common stock and another $500 million in trust preferred securities. The stock’s valuation doesn’t appear to reflect the company’s balance sheet and operating improvements.

Suntrust Banks (STI), as its name implies, has a major presence in Florida (33% of deposits) and Georgia (29%). The Florida market was one of the epicenters of the subprime collapse, and Suntrust is still digging out from that debacle. The company’s 2012 capital plan fell short, but its rebuilding efforts led to it passing this year’s tests. While it continues to unload loans on distressed properties, it will be able to pursue a $200 million share-repurchase program and boost the dividend.

US Bancorp (USB) was among the first of the nation’s banks to repay its federal bailout funds. Management gets high marks for maintaining strong financials, which have allowed the company to make acquisitions during a time when many banks are still selling assets. It just received approval to increase the dividend by 18% and institute a new $2.25 billion stock repurchase program and is also among a small group of banks that are not only expected to survive under the worst-case, stress-test scenario but to actually remain profitable.

Wells Fargo & Co.’s (WFC) product line covers nearly every imaginable aspect of consumer, commercial and investment banking services. As one of the largest originators of mortgages, Wells should benefit from the rebound in the housing market. Management has also made a commitment to managing costs. Wells recently received permission from the Fed to raise its dividend and increase its share buyback program.

Zions Bancorporation (ZION) has its largest presence in Utah and California, followed by Texas, Arizona and Nevada. The California and Nevada markets were particularly hard hit during the financial crisis, but Zions has subsequently done a good job of reducing its non-performing assets. Management received Fed approval for actions that will bolster the firm’s capital position. Zions is well positioned to capitalize as its geographic markets recover.

Banks: Undervalued Assets for The Long Haul

Disclosure: The author is long BAC and STI.