Home News Back to Basics: A Strategy for Investing in Banks

Back to Basics: A Strategy for Investing in Banks

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As the nation’s largest banks prepare to release their second-quarter results, caution looms in the air. However, this uncertain climate can present opportunities for those with a well-defined strategy.

According to analysts at Piper Sandler, a back-to-basics approach is key when it comes to identifying investible banks. Mark Fitzgibbon, head of research at Piper’s financial services group, emphasizes the importance of simple business models, competent management teams, and a track record of growing tangible book value over time.

With these criteria in mind, several banks stand out. Bank OZK (OZK), Pinnacle Financial Partners (PNFP), Prosperity Bancshares (PB), and First Citizens Bancshares (FCNCA) all exhibit a compound annual growth rate in tangible book value exceeding 10% over the past two decades. Notably, First Citizens recently acquired a significant portion of Silicon Valley Bank following its collapse in March.

However, challenges persist for banks. The recent turmoil in the industry, highlighted by the collapses of SVB, Signature Bank, and First Republic, has resulted in increased capital requirements to maintain stability. These tighter controls may limit banks’ ability to lend and distribute capital to shareholders through dividends and buybacks.

Last month, some of these concerns were alleviated when 23 of the largest banks in the country passed the Federal Reserve’s annual stress test. This clearance allowed banks to update their capital plans, resulting in many announcing higher dividends. However, announcements regarding buybacks were more subdued.

Yet, despite the news of potentially higher dividends, many investors have been hesitant to enter the industry. With expectations of a 7% year-over-year decline in second-quarter earnings per share, according to Keefe, Bruyette & Wood analysts, the allure of the sector has diminished. The SPDR S&P Bank ETF (KBE), which experienced a 30% decline just two months ago, has only partially recovered, currently down by 18%.

In this environment, it becomes crucial for investors to stay vigilant and consider the fundamentals. By adhering to a back-to-basics strategy, centered around banks with straightforward business models, capable leadership, and a history of growth, opportunities can be found even in uncertain times.

The Future of the Banking Industry

In the face of ongoing concerns regarding the banking industry, some analysts are taking a more positive stance. Jefferies, a prominent financial services company, recently upgraded JPMorgan Chase (JPM) to a Buy rating, expressing a preference for Buy-rated Morgan Stanley (MS) and Goldman Sachs (GS) as well. The basis for these upgrades lies in the fact that these banks are less reliant on net interest income, have more stable revenue streams, and pose less credit risk.

It is worth noting that JPMorgan’s stock has already experienced significant gains this year, surpassing losses within the banking index. However, despite this growth, Jefferies still views JPMorgan as a strong investment. According to Ken Usdin, an analyst at Jefferies, factors such as stable earnings outlook, impressive return on equity profile, conservative reserving history, and improved revenue diversity contribute to their decision to upgrade JPMorgan.

JPMorgan will be the first major bank to report its earnings on Friday, followed by Wells Fargo (WFC) and Citigroup (C). Goldman Sachs, Morgan Stanley, and Bank of America (BAC) are expected to report their earnings next week.

While concerns over the potential fallout from previous banking turmoil have largely subsided, investors are now turning their attention to how banks are navigating the current challenging economic climate. As households gradually deplete their pandemic savings, banks anticipate an increase in credit defaults to approach pre-pandemic levels.

Furthermore, the expectation of higher interest rates poses additional challenges for banks. Banks continue to grapple with billions of dollars of unrealized losses stemming from falling bond prices. Additionally, with higher interest rates, banks are expected to pay out more to their depositors, thereby reducing the interest income they earn from loans. This, in turn, has dampened deal-making activity in the investment banking sector as financing mergers and acquisitions has become more expensive.

Despite these headwinds, there are still opportunities for those with patience. The future of the banking industry will greatly depend on how banks adapt to the changing economic landscape.

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