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SKARBECK: Big banks worth a look at today's cheap prices

February 20, 2016

Ken SkarbeckAs 2015 came to a close, investors were bullish on bank stocks. With the Fed finally raising interest rates, investors assumed banks soon would be reporting earnings increases. Rising rates are good for banks because they increase the spread between what banks charge on loans and what they pay for deposits and other funding.

However, as the calendar turned to 2016, a number of events conspired to cause a swift selloff in large U.S. bank stocks. Of course, the broad stock market has come under recent stress, but by mid-February, bank stocks were the worst-performing market sector, having fallen 16 percent, or twice as much as the S&P 500. In the first six weeks of the year, Bank America fell 34 percent, giving up three years of gains. Citigroup, JPMorgan Chase, Wells Fargo and others all have seen their stock prices hit hard.

Part of the swoon can be attributed to the pummeling European bank stocks have taken. Concern over the quality of Deutsche Bank’s capital base sent its stock reeling 35 percent lower this year, while Switzerland-based Credit Suisse fell 40 percent (both have since rallied a bit off their lows.) In addition, several foreign central banks instituted negative interest rates, which jarred many investors into thinking the profit recovery for financial firms could be years away. The Fed even announced, ill-timed perhaps, that, when conducting this year’s stress test on U.S. banks, it will include a scenario of negative three-month Treasury rates.

Adding further to anxieties, sinking oil prices have investors wondering how many bad loans the banks hold in the energy sector. The decline in the high-yield bond market is sometimes viewed as a proxy for riskier loans banks hold on their balance sheets. High-yield bonds fell nearly 5 percent last year, their worst performance since the credit crisis. Currently, banks have set aside only about 1.45 percent of total loans as reserves against future non-performing loans.

So investors have begun to doubt whether the Fed can continue to raise U.S. interest rates. To wit, on the heels of this market turmoil, investors have flocked to the safety of Treasury bonds, sending the 10-year U.S. Treasury rate to a 10-month low of 1.86 percent.

Considering all these reasons, it is easy to see why investors are concerned about bank stocks. Yet, barring a broad economic downturn, which doesn’t seem to be in the cards, there are reasons to like U.S. bank stocks at these lower prices.

U.S. banks today have two to four times the capital ratios they had in 2009, and have reduced leverage considerably. For the 92 largest U.S. banks, each with assets over $10 billion, non-performing loans were only 1.2 percent of total loans as of September 2015.

In a noteworthy sign of confidence, JPMorgan Chase CEO Jamie Dimon on Feb. 11 opened his checkbook and bought 500,000 shares of his company’s stock for $26.6 million. JPM’s stock had fallen 20 percent this year, but popped 8 percent higher on this news.

Regulatory changes following the credit crisis strengthened the balance sheets of large U.S. banks. With their increased safety, decent earnings growth and future dividend increases, large U.S. banks offer a conservative choice for investors at today’s prices.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. He can be reached at 818-7827 or ken@aldebarancapital.com.

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