The financial sector remains one of the few truly under-appreciated areas of the stock market. Though we can all remember the havoc caused by financial bets that turned sour, the current state of our nation’s biggest banks give no signs that investors should be keeping their distance. In fact, some of the country’s best investing minds have taken up large holdings in banks, at a time when most fear a repeat of 2008. Here are the top three reasons banks are a good investment now and will continue to be in the future.
One of the biggest boons for the banking sector has been the resurgence of the housing market. While it is not at full steam yet, housing has steadily been recovering, with improvements in housing prices, home improvement, housing sales, and new home building. Banks, in turn, have been reaping the benefits of consumers returning to the housing market, mainly through mortgages and refinancing loans. In the fourth quarter of 2012, the nation’s top five banks underwrote $237.6 billion in home loans:
| Bank | 4th-Quarter Mortgage Originations |
|---|---|
| Wells Fargo (NYSE:WFC) | $125 billion |
| JPMorgan Chase (NYSE:JPM) | $52.1 billion |
| Bank of America Corp (NYSE:BAC) | $22.5 billion |
| US Bancorp (NYSE:USB) | $22.1 billion |
| Citigroup (NYSE:C) | $16.8 billion |
Source: Company Q4 2012 earnings releases.
While a solid 70%+ of that activity was based on mortgage refinancing, there is plenty of room to grow as the housing market continues its upward climb. And if the bill mentioned by President Obama in his State of the Union address Tuesday passes, allowing a multitude of homeowners to refinance their mortgages to today’s rates, the banks will have an influx of new fee revenue. Add the declining mortgage delinquency rate on top of the new loans coming in, and you’ve got a recipe for bank success.
Some believe the mortgage activity slow-down we’ve been seeing in the last few weeks will hurt the bank’s chances of repeating the fourth-quarter’s boom. But evidence shows that rising interest rates are the catalyst behind the slow down, so banks may still have the upper hand.
Most of the banks reported continued pressure on their net interest margins in the fourth quarter. Stemming from record-low rates, the pressure caused banks to rely on non-interest income for much of their revenue — think origination fees. And with all of the origination activity in the fourth quarter, most banks were able to sufficiently cover declines in interest income due to narrowing margins. As rates begin to increase, the banks may have less fee income, but expanding margins will begin to cover those revenue drops.
The bottom line
Banks have been reporting record earnings, an undeniable sign that their business models are once again operating at full steam. Wells Fargo brought in $18.9 billion in 2012, a record for the company, with plenty of thanks to its mortgage division (see above). Likewise, JPMorgan’s earnings rose 35% from 2011, bolstered by the bank’s asset management and investment banking segments, on top of its consumer banking improvements. And while Citi and B of A may not have posted numbers as impressive, they are both improving in other ways that may reach their bottom lines shortly.
With top investors like Warren Buffet and Bruce Berkowitz investing heavily in banks, investors should feel confident that they are in good company. Berkowitz has even said that he expects his largest holdings (of which BAC is No. 2) to quadruple in the next five to seven years — that’s a glowing endorsement for a bank that has been relegated to the bottom of the barrel.
With a boost from the housing market still growing, and improved operations, the banks are poised for growth in the coming years. As impressive as the record earnings reported in the last quarter were, there are sure to be further improvements and more record earnings to come.
It’s a balancing act
The fear of another financial crisis may be what keeps investors at bay, but it’s what has spurned the banks to strengthen themselves. After the disaster of 2008-2009, most of the banks and other financial companies that contributed to the economic fall have taken steps to reduce their exposure to risk. Often, this has resulted in banks returning their focus to consumer banking, which had benefited banks like Wells Fargo and (NYSE:WFC) US Bancorp during the financial crisis because of reduced risk exposure.
At the same time, regulation changes had banks stock-piling capital. Just in time for regulators to announce changes to the new Basel III capital requirements, the nation’s largest banks reported impressive capital reserves:
| Bank | Tier I Capital Balance | Capital Ratio Under Basel III |
|---|---|---|
| Bank of America | $128.6 billion | 9.25% |
| Citigroup | $105 billion | 8.7% |
| JPMorgan | $144 billion | 8.7% |
| Wells Fargo | $113.9 billion | 8.18% |
| US Bancorp | $24.9 billion | 8.1% |
Source: Company Q4 2012 earning presentations.
As you can see from the table, even the most traditional banks, WFC and USB, have their shortcomings when it comes to the ability to quickly raise capital. Boosted by their increased capital reserves, both Bank of America and Citigroup continue to trade below tangible book value, giving investors an opportunity to buy the undervalued stocks and see their money grow as both the banks book value and prices continue to appreciate.
At a time when investors still aren’t sure of the banking sector’s financial stability, it remains a fact that the nation’s banks have been working diligently to improve the balance sheets. All the while, Wall Street continues to look at the banks with clouded vision.
The article 3 Reasons You Should Be Buying Bank Stocks Right Now originally appeared on Fool.com and is written by Jessica Alling.
Fool contributor Jessica Alling has no position in any stocks mentioned, but you can contact her here. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo.
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