How to play the bank-stock panic

If you're looking to sell shares of large banks after Friday's FHFA lawsuits, it's probably too late. Instead, consider the many solid banks that don't have mortgage targets on their backs.

By TheStreet Staff Sep 6, 2011 12:33PM

By Philip Van Doorn, TheStreetTheStreet

 

If you're thinking of dumping large bank stocks Tuesday in reaction to last week's FHFA lawsuit bombshell, you might want to reconsider.

 

Instead, take a deep breath and mull some other bank stock opportunities, because the automated traders and other market pros will clean your clock if you try to trade based on the lawsuit headlines.

 

It's perfectly understandable for bank stock investors to panic over the long holiday weekend. After all, it was a week of maximum pain for Bank of America (BAC), with the Federal Deposit Insurance Corp., a subsidiary of U.S. Bancorp (USB) and Goldman Sachs (GS) joining the throng of parties objecting to BofA's previous $8.5 billion settlement of Countrywide mortgage putback claims.

 

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And of course, there was the Federal Housing Finance Agency's (FHFA) Friday Night Massacre of lawsuits against 17 large banks.

 

(In case any reminder is necessary, former Bank of America CEO Ken Lewis decided to buy Countrywide and its risk in 2008.)

 

Shares of Bank of America were down another 4% on Tuesday, and down more than 47% year-to-date. The shares traded for just 57% of their tangible book value as of June 30, according to SNL Financial, which is understandable, because neither the bank nor its investors can gauge the ultimate risk from all of the mortgage putback claims.

 

Of course, the company's tangible book value could decline over coming quarters with additional net losses, but the market has baked a significant cushion into Bank of America's stock price.

 

That plunge was recorded before the FHFA's demand that Bank of America buy back $57.5 billion in private-label mortgage-backed securities, including those sold to Fannie Mae (FNMA) and Freddie Mac (FMCC) by Merrill Lynch and Countrywide.

 

For investors who think that the FHFA lawsuits are just "leverage" for the regulators in negotiating a settlement with the nation's largest bank, another price drop on Tuesday could be just what the doctor ordered.

 

But it's a pretty risky play to assume that such a selloff would be the bottom for bank stocks. There are just too many uncertainties right now.

 

JPMorgan (JPM) was trading for 1.1 times tangible book, according to SNL, but that was before the company faced a whopping demand from the FHFA to repurchase $33 billion in mortgage-backed securities, which among the 17 large banks sued by the regulator, is second only to the demand made of Bank of America. 

 

Shares of Citigroup (C) were also trading for just 57% of tangible book value according to SNL, and the FHFA is demanding a much smaller $3.5 billion in securities buybacks from Citi.

 

With last week's economic news dominated by the dismal announcement from the U.S. Labor Department that the U.S. economy added no new jobs during August, all eyes will be on President Obama when he delivers an address to a joint session of Congress on Thursday at 7 p.m. ET. The president is expected to propose a large infrastructure program as part of his plan to spur job creation.

 

If the president also makes a public case for a broad settlement of the nation's housing mess, bank stocks could pop on Friday.

 

The FHFA's vicious blow against many of the largest banks that were part of the federal government bailout of 2008 through the Troubled Assets Relief Program, or TARP, underlines the need for presidential leadership in a coordinated government response to the overall housing mess.

 

It might be too late for President Obama to help his re-election prospects with a mortgage settlement, but the prospect of a settlement to stabilize housing prices, clear out the inventory of empty homes, spur mortgage refinancing and get the economy moving again could make the market very happy.

 

Looking beyond the almost daily seesaw for the largest banking names, there are dozens of banks that have achieved strong revenue growth in the weak economic environment and don't face the level of mortgage risk and headline risk faced by the largest and best-known financial names.

 

For starters, TheStreet has identified 10 banks with solid revenue that have achieved real second-quarter revenue growth year over year, irrespective of the loan loss reserve releases that have been padding the earnings of most of the large banks.

 

People's United Bancorp (PBCT) features prominently among them, with second-quarter preprovision (for loan losses) net revenue more than doubling year over year, to $98.4 million, according to SNL Financial.

 

Using the same criteria for year-over-year revenue growth, we also highlighted 10 small banks with double-digit revenue growth.

 

For investors seeking relatively safe banking plays that have posted strong earnings results right through the credit crisis, there are also rational bank stocks for an irrational market.

 

Bank of Hawaii (BOH) is one of the quality banking names featured here, with a return on average assets ranging between 1.08% and 1.70% over the past 10 quarters.

 

For investors looking for banks achieving the Holy Grail of solid loan growth in a tepid economic environment, the winners on this list include M&T Bank (MTB), with commercial and industrial loans increasing 18% year-over-year, mainly from the acquisition of Wilmington Trust, and the ever-expanding First Niagara Financial Group (FNFG), which grew its C&I portfolio 62% year-over-year, mainly from its NewAlliance acquisition.

 

During times of uncertainty, dividends provide comfort to investors, especially when the payouts are generous and well-supported by earnings. Dime Community Bancshares (DCOM) is a nice, steady play from this camp, with a dividend yield well in excess of 5%, and its 14-cent quarterly payout is only 39% of its second-quarter earnings of 36 cents a share.

 

Credit card lending is a great business to be in right now, especially if it's your focus. Discover Financial Services (DFS) is a world-beater, with a fiscal second-quarter operating return on average assets (ROA) of 3.76%, according to SNL Financial. American Express (AXP) ain't too shabby either, with a second-quarter ROA of 3.55%.

Despite what looks like a very rough Tuesday for investors holding financial names, there's always hope. The best thing to do is really put on your thinking cap, stick with quality for new picks, do as much of your own research as possible and, again, don't panic.

 

1Comment
Sep 6, 2011 8:13PM
avatar
I haven't held bank stocks since I sold BAC at around $40, which seems like ancient history.  You want bank stocks?  Feel free.  I can get my 5% dividend elsewhere with a lot less risk. 
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