TD - Bank Stock Panic: 5 Attractive Buys That Could Benefit

2023-03-15 16:32:01 ET

Summary

• SI, SIVB, and SBNY have failed over the last week. Some other banks are struggling.
• Bank stocks have been sold off indiscriminately.
• Some banks could benefit from the current environment in the long run. Thanks to low valuations, they seem attractive right here.

Article Thesis

The failure of Silvergate Capital ( SI ), Silicon Valley Bank ( SIVB ), and Signature Bank ( SBNY ) has caused markets and many on Main Street to worry about the health of the banking industry. Recent struggles at Credit Suisse ( CS ) have further amplified fears. And yet, not all banks are in trouble -- it looks like some could actually benefit from what is going on today. In this report, we'll highlight 5 attractive bank stocks.

What Happened?

Silvergate Capital, a crypto-focused bank, was the first to struggle. Late last week, Silicon Valley Bank was closed down, as customers rushed out to draw their deposits as it became clear that the bank was struggling. Shortly after, the bank had to be taken over by the FDIC. Much has been said about the causes of that, but in short, the bank had mismatched durations of its liabilities and assets, which forced it to sell treasuries at a huge loss (relative to par value) in order to generate liquidity. This, in turn, resulted in declining equity, which caused its customers to become wary and pull out cash, and this bank run ended the company.

Signature Bank followed on Sunday, being closed down as well. And many other banks, mostly community banks and regional banks, are struggling. Banks with below-average equity positions, a high portion of uninsured deposits, and large looming mark-to-market losses in their bond portfolios are especially at-risk. That's why some of these community and regional banks have seen their shares slump in the recent past, even though it is not clear whether they will experience a similar fate compared to SI, SIVB, and SBNY:

First Republic ( FRC ), PacWest ( PACW ), and Western Alliance ( WAL ) are, in the eyes of the market, among the riskiest banks, as their shares have fallen 42% to 67% this year alone. Whether any of these banks will actually fail is not certain, of course, but the market is seeing major risks here. But even the broader indices for regional banks ( KRE ) and overall banks ( KBE ) have taken major hits so far this year, declining by 23% and 17%, respectively, in 2023.

And it looks like this is not a purely US-based phenomenon, showcased by the struggles of Credit Suisse, which has seen its shares slump by 67% over the last year, and which has apparently asked the Suisse National Bank for a public show of support after identifying "material weakness" in its reporting procedures.

Some Banks Could Actually Benefit From This Crisis

But do these issues that some banks experience mean that all banks have a problem? The contrary could be true -- some banks might actually benefit from the struggles of the hardest-hit banks. When customers become warier about the prospects of a smaller bank, they might decide that putting their money elsewhere, e.g. to a too-big-to-fail bank, is an opportune idea. The largest banks are, in the eyes of many, the least risky ones, as they will have government support even if things go south. It is thus not too surprising to see that the largest banks in the US, such as JPMorgan ( JPM ), Bank of America ( BAC ), and Citigroup ( C ) have seen their deposits grow over the last couple of days. Bank of America alone has added $15 billion in deposits, as customers have been moving cash away from (presumably) riskier small banks to the largest TBTF banks. The presumed lower risks of the largest banks attract customers, and if they move their cash and savings to these banks, they might be more inclined to do other business with these giants as well going forward, which could result in business growth potential for JPM, BAC, Citi, Wells Fargo ( WFC ), and so on.

If smaller banks fail or struggle, they might also be easy targets for takeover by the largest players. When equity valuations for banks such as First Republic drop massively, it seems possible that one of the giants sweeps in to take over said smaller peer at favorable prices. Even when a bank fails, some parts of that bank will hold some value, and the largest banks are best positioned to acquire those still-valuable parts.

One example of such a well-timed acquisition of assets at a favorable price is Goldman Sachs' ( GS ) takeover of some assets from SIVB -- it is expected that Goldman Sachs will make a pretty hefty $100 million via this deal. The largest players with the deepest pockets can be expected to make additional such well-timed acquisitions if struggles in the banking industry persist.

And yet, the valuations for these large banks have come down as well, potentially making them attractive investments. They aren't really at risk of a bank run, they can attract new customers thanks to being perceived as low-risk due to their too-big-to-fail status, and they can acquire assets at attractive prices. With these major banks trading at pretty undemanding valuations, they could be good medium- to long-term investments, I believe.

Today, JPMorgan trades for 10x this year's earnings, for 9.5x next year's earnings, and the company offers a dividend yield of 3.1%. While it is the most expensive among this group, it is still inexpensive in absolute terms -- and the premium versus its peers may very well be justified thanks to it being seen as the largest and strongest bank in the US. Bank of America is a little cheaper, while Citigroup is even cheaper than BAC. Since Citigroup also offers the highest dividend yield by far, at 4.6%, I deem it quite attractive. Goldman Sachs has a different business model than the other banks seen here but is attractive as well. The valuation is pretty low, and a recently-announced $30 billion buyback program could shrink the share count massively. Deals such as the one mentioned above, where GS will likely earn around $100 million thanks to acquiring SIVB assets on the cheap, show that GS is well-positioned to benefit from volatility in the industry.

Another bank I like at current prices is Toronto-Dominion ( TD ). While TD is not US-based, it nevertheless has seen its share price decline meaningfully in the recent past -- at US$58 per share, it trades 30% below the 52-week high. Canada has not been hit by bank failures in the current environment, thus the risk of a bank run on TD seems very low. And yet, shares have pulled back enough to make TD trade at just 9x net profits. Like the biggest banks in the US, the largest players in Canada could also benefit from consumers shifting their funds to the largest TBTF banks, which would be beneficial for TD. TD also offers a dividend yield of 4.8% at current prices, which is pretty attractive. When we consider that the Canadian banking industry overall, and TD specifically, has done well in past crises, including the Great Recession, TD seems like an attractive pick from a risk-reward perspective at the current price, I believe.

Takeaway

A couple of failures of mid-sized banks in the US, and struggles at Credit Suisse, have made markets very jittery when it comes to bank stocks and other financials. But not all of them are experiencing troubles -- some of the largest banks could actually benefit from the struggles that some community and regional banks experience, as this allows the biggest players to attract new customers and buy assets on the cheap.

JPM, BAC, C, GS, and Canada-based TD seem like attractive picks at current prices. While no investment is risk-free, and while the current situation might escalate, it seems unlikely that these will experience a bank run -- so far, their deposits are growing while smaller banks experience bank runs. Due to low valuations and solid to attractive dividend yields, these bank stocks could be compelling investments over the coming years, at least as long as the current crisis does not escalate massively.

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