Bank stocks are tumbling in the wake of the failures of SVB Bank SIVB and Signature Bank SBNY ), but there are good reasons to make this contrarian investment.
First, federal regulators have made clear they will support banks on the edge of trouble because of depositor flight. The Federal Reserve will lend to banks against the full value of losing positions in Treasurys. “That will help banks meet deposit requests,” says Ian Lapey, the portfolio manager of the Gabelli Global Financial Services Fund
Second, regulators have signaled they’ll back bank deposits above the $250,000 cutoff for Federal Deposit Insurance Corporation?(FDIC) insurance.
“That should reduce the panic of depositors in general because the government is saying you are not going to lose money,” Lapey says. “There is really is no reason now for a depositor to pull money out of any bank unless they think they can get a better rate.”?
Regulators won’t stop there if more trouble arises. “The FDIC, the Treasury and the Federal Reserve will ultimately do what they have to do to bring calm to the banking system,” Harbor Capital Advisors strategist Spencer Lerner said in a client call Monday.?
Third, yields on Treasurys have fallen significantly. This increases the value of debt securities that banks hold, improving their financial strength, Lapey says.
Read: Government bonds held at banks may be so-called ‘toxic asset’ of next financial crisis, fund manager says
If you’re thinking about investing in the banking sector now, consider these strategies:
1. Go big: The most conservative way to get exposure to the bank sector is through shares of the big money-center banks. The potential gains are smaller, but these stocks haven’t fallen as much as the regional banks and are much less likely to tank.?
The biggest banks might even be winners in the crisis. If depositors flee regional banks, big banks will take deposit share because they’re viewed as safer, Lapey says. This makes sense because the big banks have much more diversified businesses. JPMorgan Chase
Read: It’s raining money on Bank of America. Inflows of over $15 billion reportedly seen amid SVB fallout
Lapey singles out Citigroup
To calculate tangible book value, Lapey takes a more conservative approach than a lot of sector analysts. He discounts the value of Treasurys and other debt instruments that banks carry at full value because they say they will hold them to maturity. Lapey’s more conservative approach to valuation shows Citigroup has a tangible book value of $70 per share. Large banks such as Citigroup start to look attractive at tangible book ratios in the low one range, and for this bank the ratio is .67. Citigroup is well capitalized, says Lapey, and it pays a 4.3% dividend yield.?
2. Go with the big regional banks: Small regional banks face the risk of depositor flight and rising funding costs and will need to raise rates to keep deposits, cautions Hennessy Large Cap Financial Investor
So-called superregionals including Fifth Third Bancorp?
One reason is these banks mainly do basic, traditional local community banking, offering working capital loans to companies, home mortgage loans, and credit card loans. “They don’t do many big commercial real estate loans or loans to riskier startups,” Ellison says. “Their traditional banking model is tried and true over credit cycles.”?
Plus, their core deposit base is safer because it is more “granular.” This means they have a lot of smaller deposit accounts with insured balances below $250,000. These customers are less likely to transfer their accounts. For comparison, at SVB Bank about 90% of deposits were uninsured. At these large regional banks it’s in the 30% to 40% range.?
All of these banks pay nice dividend yields in the 4% to 6% range.?
3. Go small: Small banks have strong business relationships with their customers, says Tim Melvin, of the Bank Takeover Letter which tracks activist buying at banks to try to identify takeover targets.?They also lack exposure to venture capital-backed startups and crypto companies, which got SVB Financial and Signature Bank in trouble.?
One bank that Melvin likes is LCNB
Lapey, at Gabelli, highlights Glenville, N.Y.-based Trustco Bank
4. Wait for the dust to settle: Not everyone is convinced it is time to buy the bank sector sell off. Larry McDonald of the Bear Traps Report, says banks face the risk of dilution if they need to turn to the stock market to sell shares and raise funds. He adds that Washington’s rescue plan is not all it’s cracked up to be. He thinks banks will be reluctant to go to the Fed discount window to take out loans against Treasurys because investors will see it as a sign of trouble. To avoid this issue in the Great Financial Crisis, regulators forced all major banks to take support, whether they needed it or not.?
Another looming problem is that banks pull back on lending to preserve their balance sheet strength, says Ellison, at Hennessy. This will cut into revenue growth. Meanwhile, they will have to pay more on deposits and this will hit profit margins, adds Ania Aldrich, a portfolio manager at Cambiar Investors. “There will be more negative than positive news for banks,” she says. “Earnings will continue to be revised lower.”
Plus, the loan contraction could accelerate any economic recession that was already on the way. “Banks are tightening lending standards and small companies get hurt the most,” says Lerner, at Harbor Capital Advisors. That matters because small companies are the backbone of the economy. “That pulls forward the timing of the recession we were expecting.” If there is a recession, that’ll make matters even worse for banks.?
Finally, there is the risk of another bank shutdown sparked by another bank run. Says Ellison: “You never know.”
Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested JPM, C, and FITB in his stock newsletter,?Brush Up on Stocks. Follow him on Twitter @mbrushstocks
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Also read: SVB’s collapse exposes the Fed’s massive failure to see the bank’s warning signs