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If you hate big banks, you are part of a tradition going back centuries. But don’t let that cloud your investment judgement.
You should own big banks now for their rich dividends. They are secure despite the economic turmoil. Their stocks look cheap. And banks perform well as economies recover — which is likely from here. “Banks will be doubles or triples in a few years,” predicts Ian Lapey, who manages the Gabelli Global Financial Services Fund GGFSX, -0.41%.
But not just any banks. Narrow the field by favoring big banks with a broad mix of businesses, including investment banking. This gives them the funds needed to offset the reserves they’re posting against bad debts because of the COVID-19 crisis.
Here’s a look at four reasons to own the big banks, and some of the best ones to own.
They just posted great quarters
Even though the economy fell apart in the second quarter and banks had to reserve heavily against bad debt, many of them had a great quarter.
JPMorgan Chase JPM, +2.67% reported record revenue of $33.8 billion, up 14% from the year before. Net income of $5.5 billion was up 64% from the first quarter. The strength was driven largely by investment banking business, as clients scrambled to raise capital to protect against possible tough times ahead. JPMorgan investment banking fees were up 54% over the prior year.
The strengths at this bank probably explain the recent insider buying, one reason I singled out JPMorgan as a favorite in my stock newsletter Brush Up on Stocks on June 30 at $94 a share.
At Citigroup C, +3.05%, it’s a similar story. Revenue grew 5% to $19.8 billion over the prior year because of strength in investment banking, while revenue grew 37% to $1.8 billion. That was the best quarterly take in this business since the financial crisis. The bank was profitable, with net income of $1.3 billion despite the hefty reserves. Citi saw decent loan and deposit growth, as did JPMorgan.
“A big difference from the financial crisis is that their investment banking business is booming, and this helps offset credit reserves,” says Lapey. Investors are lumping banks in with sectors hit hard by COVID-19 like gaming, hotels, travel and airlines. “But demand for banking has never been stronger, and many banks have performed extremely well,” says Lapey.
They pay nice dividends, are they are secure
Citigroup offers a 4% dividend yield. At JPMorgan it’s 3.7%, and at Bank of America BAC, +3.41% you get a 3.1% yield.
Lapey doesn’t own JPMorgan and Bank of America, but I’m throwing them in because they are quality banks with strong management, and their stocks are still down so much this year.
Dividends at the big U.S. banks look secure because they have so much investment banking profit for bad debt reserves (aside from Wells Fargo WFC, +5.98%, which doesn’t have as big an investment banking business).
• Citigroup plowed $5.6 billion into credit reserves last quarter. It has a comfortable 11.5% Tier 1 capital, a regulatory measure of equity capital and reserves against risk-weighted assets. That’s 1.5 percentage points above its regulatory minimum. It won’t have to raise capital and dilute earnings, says Lapey.
• JPMorgan put $8.9 billion into reserves and suspended stock buybacks to defend its dividend. Its Tier 1 capital ratio went up to 12.4% from 11.5%. “We could bear another $20 billion of loan loss reserves,” said CEO Jamie Dimon. “We can easily get through very, very tough times and never cut the dividend.”
• Bank of America added $4 billion in loan loss reserves and boosted its Tier 1 ratio slightly to 11.4% from 11.2%, nearly two percentage points above its regulatory minimum. It could do this because investment banking fees grew 57% year-over-year to $2.2 billion.
By now, the worst may be over for bad loan charge-offs. They may increase “but you won’t necessarily see that hurt earnings because the reserves have already been booked,” says Lapey.
For dividends also consider Jefferies Financial Group JEF, +2.73%, a smaller investment bank which pays a 3.5% yield, and two custody banks — Bank of New York Mellon BK, +1.44% with a 3.3% yield and State Street STT, +2.66%, which pays a 3.4% yield. Custody banks hold assets like stocks and bonds for brokerages and investors, and they manage the nuts and bolts of the markets like trade settlement. They don’t do much lending, so there is far less credit risk.
The banks look cheap
Citi trades at 70% of tangible book value of $71.15. Jefferies trades at 65% of tangible book value of $25.51. Bank of America and JPMorgan don’t look as cheap. But they’re still down significantly year to date, compared to a near-recovery in the S&P 500 index SPX, +0.44% and the Dow Jones Industrial Average DJIA, +1.12%, and the new highs for the Nasdaq Composite COMP, -0.61%. Bank of America trades at 1.2 times tangible book value of $19.90, and JPMorgan trades at 1.6 times $61.76 book value.
Banks do well in a recovering economy
OK, this part is controversial because no one really knows, given all the uncertainty about the virus. But Europe and much of Asia have demonstrated it’s possible to ease out of the lockdown without creating a spike in cases, and I think we could learn to do the same in the U.S.
Meanwhile, progress on vaccines continues at AstraZeneca AZN, -0.71%, Pfizer PFE, +0.68%, BioNTech BNTX, +5.70% and Moderna MRNA, -2.87%. Ditto for treatments at Eli Lilly LLY, -0.85%, Gilead Sciences GILD, -1.25% and Takeda Pharmaceutical TAK, -0.53%. Besides, we have made a lot of progress on “herd immunity” this summer, and we better understand how to protect vulnerable populations.
Follow the latest on coronavirus here.
Banks do well in rebounds because business picks up, bad loans decline and investment profits improve relative as the yield curve becomes more upward-sloping. The Federal Reserve and politicians in Washington, D.C. have injected a ton of stimulus, which also supports a rebound.
Foreign banks
Large foreign banks look cheap, too, and many pay nice dividends.
• Shinhan Financial Group SHG, +1.30% in Korea pays a 6% yield. Korea has managed the COVID-19 crisis better than the U.S. as well, so the dividend looks secure. This bank goes for 44% of book value, says Lapey. He expects increased share repurchases and a possible dividend hike.
• Daiwa DSEEY, -0.96% in Japan offers a 4.1% dividend yield and it trades at 67% of tangible book. Daiwa has little credit exposure. It’s mainly an investment bank.
• Credit Suisse CS, +1.02% trades at 55% of tangible book and it pays a 2.8% yield. It’s secure because the bank has less loan exposure, and Switzerland has done a good job of containing the economic impact of COVID-19, says Lapey.
Lapey also likes Barclays BCS, +1.37% and Commerzbank CRZBY, +1.43%. They look cheap at 41% and 23% of tangible book value. Regulators in the UK and Europe have blocked dividends. But they’ll resume at some point.
Meanwhile, you’re probably not missing out on the cash these two would be paying out. “They are retaining the money,” says Lapey. “They may do special dividends to make up for the fact that they are not paying dividends now.”
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested JPM, C, WFC, BK, AZN, PFE, LLY and GILD in his stock newsletter Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School. Follow him on Twitter @mbrushstocks.
