Investing: Is it time to bank on bank stocks?
— -- Sure, banks have made some mistakes. There was that incident about Bank of America charging its own customers $5 a month to use their ATM cards. And then there was that whole wrecking-the-economy thing. It's been a tough few years.
But bank stocks have recovered somewhat from the soul-searing, portfolio-wrecking lows of 2009 and seem to be reasonably priced these days. Should you invest? Probably. But you need to keep at least one eye, and preferably two, on developments in Europe.
The basic banking business, while not simple, isn't rocket science. You borrow from customers at one rate, and lend to customers at a higher rate. The difference, plus the fees attached to deposits and loans, are your profit. In a normally functioning economy, banks should be relatively staid but profitable companies.
Periodically, however, the industry has bouts of madness, in which it tries to become a growth industry by making risky investments. In the 1970s and early 198s, it was loans to Latin America. In the 1980s, it was Texas and New England real estate lending. In 2006, it was loans to shaky borrowers on overpriced real estate, and securities backed by those loans.
From January 2008 through March 2012, 430 banks failed, according to the Federal Deposit Insurance Corp. Most of those have been resolved by being merged into a stronger bank, rather than outright liquidation.
The banks that were the most problematic were those that were too big to fail — in other words, those that were so big that they dwarfed the FDIC's ability to liquidate. Those banks, and many others, took funds from the Troubled Asset Relief Program, or TARP, which was signed into law by then-president George W. Bush. TARP was designed to remove the most toxic loans from banks' balance sheets.
Many of the largest banks have repaid their TARP loans and are on their way to stability. "They're paying attention to what they're doing, they're not taking anything for granted, and regulators have their thumbs on them," says David Ellison, manager of FBR Large Cap Financial Fund.
Many large banks have relatively modest price-to-earnings ratios, using 2012 earnings. (PE ratio is a stock's price, divided by its expected 12 months' earnings. Lower is cheaper.) "Historically, that's been a time to buy, not sell," Ellison says.
Cheap stocks usually have a reason for being cheap. In this case, there's still lingering distrust of large banks, given the unpleasantness in 2007 to 2009.
Aside from smoldering resentment, investors have another reason to be wary of bank stocks: Europe. While most U.S. banks have divested themselves of worrisome European debt, a European collapse could cause the already fragile U.S. recovery to collapse, as well. In a recession, banks make fewer loans, and they take more losses from default.
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