Investors may be able to once again find value in large bank stocks after the sector has sold off this year, mainly due to fears of a recession hitting sometime later this year or in 2023. Banks are cyclical businesses, so they usually don’t perform too well during a recession. However, banks are also about to enjoy the most prominent rising interest rate environment they’ve seen since the Great Recession, which could result in soaring profits. Of the three largest and most traditional U.S. bank stocks, let’s take a look at which one you should consider buying, given the recent pullback.
The case for Bank of America
Bank of America (BAC -3.88%), the second-largest bank in the country, received a lot of attention after Warren Buffett and his company Berkshire Hathaway plowed $2 billion into the stock during the early months of the pandemic while they were selling other large bank stocks.
The big thing Bank of America has going is its extreme sensitivity to rising interest rates, which tremendously benefits the bank’s net interest income (NII), or the money the bank makes on loans, securities, and cash after covering the cost to fund those assets. Bank of America has lots of variable-rate loans, which will see their yields reset higher as the Fed raises the federal funds rate.
The bank has also continued to improve its deposit base, which now has $1 trillion of low-cost deposits that likely won’t require the bank to pay any additional interest on through the Fed’s first 100 to 125 basis points (1% to 1.25%) of rate hikes, which have almost been fully used now. At the end of March, Bank of America estimated that a 1% hike in the federal funds rate would grow NII by $5.4 billion over the next year. At the time, the federal funds rate sat between 0.25% and 0.50%. It could end the year at 3% or higher based on the market’s current forecast.
Bank of America also thinks it can hold expenses flat this year, which is impressive given inflation. Additionally, the bank has invested significantly in technology over the years, has a big wealth management arm, and should see its trading business benefit due to all of the market volatility.
The case for Wells Fargo
The scandal-ridden Wells Fargo (WFC -6.07%) has been trending in the right direction as the bank tries to finally put the phony-accounts scandal that came to light in 2016 behind it after years of regulatory issues.
CEO Charlie Scharf seems to have been the right choice to lead the beleaguered bank. Not only does he appear to be making headway on the regulatory issues, but he’s also greatly improving the bank from an operational standpoint. His $10 billion efficiency initiative, in which management plans to cut $10 billion of annual expenses over the next few years, is already moving along, and Scharf has also sold several business units to focus the company on its core U.S. banking franchise while also looking to expand the bank’s credit card and investment banking businesses.
The big thing still holding Wells Fargo back is the asset cap the Fed placed the bank under in 2018 for the phony-accounts scandal, which prevents the bank from growing its balance sheet and therefore limits profits. Many analysts and investors might have thought the bank would be rid of the cap after four years, but nobody seems to really know when it will be removed.
On a more positive note, Wells Fargo is also a huge beneficiary of rising interest rates. At the end of March, the bank noted that a 1% move in interest rates would result in an additional $5.7 billion of NII over the next year.
The case for JPMorgan
America’s largest bank, JPMorgan Chase (JPM -4.60%), recently got a lift when management at the bank’s annual investor day raised its outlook for NII for the year from $53 billion to $56 billion in 2022 and also said it would hit an annual run rate of $66 billion of NII by the fourth quarter. JPMorgan has taken flack in recent months due to increasing its expense guidance by close to 8.5%.
But the bank has long been considered best-of-breed because it does every part of banking really well. Although it may not be as asset-sensitive as Bank of America and Wells Fargo, JPMorgan trumps the two when it comes to investment banking and trading. According to data from Refinitiv, JPMorgan Chase, so far this year, has led all investment banks in terms of fees in global investment banking, bonds, and corporate lending. At investor day, management said to expect trading revenue to come in 15% to 20% higher year over year in the current quarter due to extreme market volatility in recent months.
With Jamie Dimon at the helm, investors also have one of the longest-tenured large bank CEOs who has made it through every recession thrown his way successfully and can therefore rest easy at night knowing the bank is in good hands.
Which large bank should you buy?
I’ll preface my selection by saying that I think all three of these banks are buys and will serve investors well. Also, before I make the selection, let’s quickly take a look at valuations in terms of where each bank trades relative to its tangible book value, or net worth.
JPMorgan has the highest valuation, while Wells Fargo has the lowest. By far, Wells Fargo has the most potential upside, and I think it could reach a valuation in the ballpark of Bank of America or JPMorgan once it gets the asset cap removed. The problem is we still don’t know when that will happen, and Wells Fargo doesn’t have nearly as large of an investment banking operation as the other two banking giants. For this reason, I think investors will find the best risk-reward proposition with Bank of America, which is going to benefit immensely due to rising rates and has a solid investment bank to ride out market volatility.
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