Banks are essential parts of the modern financial ecosystem. They effectively offer a “safe” place for your money, which encourages people to deposit funds. The bank then proceeds to loan out a portion of these funds (while charging interest) for products such as home mortgages or credit cards.
While banks sometimes get a bad rep for contributing to past financial disasters via poor risk-reward balancing, when inflation strikes and central banks raise interest rates, they do have an opportunity for better profitability as their net interest income (NII) often rises, which boosts profitability on credit products. However, this is only up to a point as during a fully fledged recession, as consumer demand often wanes. A positive for banks is consumers really can only do two things with their money, spend it or save it, during a recessionary environment. Even if people have less to save, they'll still often save at higher rates during a recession.
Thus, in this article, I'm going to break down my top two favorite U.S. bank stocks and their most recent financials; let’s dive in.
1. Bank of America
Bank of America (BAC, Financial) is an iconic banking institution with over 4,300 branch locations. The company operates across a variety of business segments, which include:
- Consumer banking - Checking/savings accounts, loans, credit cards and mortgages.
- Wealth Management - Financial advice, portfolio management for institutional clients and high net worth individuals.
- International banking - This is a corporate banking function which offers services from lending to capital raising.
- Market Trading - This includes trading across multiple markets from currencies to commodities and fixed income.
Bank of America’s diversified business model and long history could put it in a solid position to weather a worsening economy. It has already survived many recessions, as shown in the chart below:
Strong financials
Bank of America reported strong financial results for the fourth quarter of 2022. Its revenue was $24.53 billion, which beat analyst expectations by $309.32 million and increased by 3.95% year over year.
These results were driven by solid performance across most business segments. On the consumer banking side, the company added 195,000 net new checking accounts, brining the total to over 1 million for the full year of 2022. Interestingly enough this was double the rate of the 2019 period and pre-pandemic.
The company also added 1 million new credit cards, which has bolstered it back to pre-pandemic levels.
Traditional banks are often criticized as being old fashioned, and out of touch with modern day digital technology. However, Bank of America has debunked this myth with 73% of its consumers being fully digitally active. The company also has over 1 billion logins to its digital platforms each month, according to its fourth-quarter earnings call.
Its credit quality has also improved with its percentage of non-performing loans declining from 3.75% in 2009 to 0.37% by 2022. This is slightly higher than the pre-pandemic 0.36%, but this is expected due to the recessionary environment.
Its wealth management business continued to expand as the company increased its advisor number by 800 and added 28,000 net new households across Merrill, previously branded Merrill Lynch, which was acquired in 2008.
A key metric to assess the profitability of a bank is its net interest income. In the fourth quarter, Bank of America reported $14.7 billion in net interest income, which increased by $3.3 billion year over year and $0.9 billion sequentially. This was driven by higher interest rates and loan growth, which has caused its margin expansion.
Of course, higher interest rates and a touch economic bankdrop has impacted the Global Markets segment. Its net interest income for global markets declined by $0.7 billion year over year.
The assess a bank's safety and liquidity, we can look at its tier one capital ratio. In this case, Bank of America's Common Equity Tier 1 (CET1) ratio was 11.2%, which increased by 25 basis points quarter over quarter.
Valuation and guru investors
Valuing bank stocks is fairly challenging, but from a traditional value perspective, we can look at the price-book ratio, which is currently 1.08. This is 5.85% cheaper than its five-year average.
The GF Value chart indicates a fair value of $40.44 per share, making the stock “modestly undervalued."
Bank of America’s most famous guru investor is none other than Warren Buffett (Trades, Portfolio) of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial). Buffett is the largest shareholder in the company and owns a 12.59% stake worth over $35 billion as of his third-quarter 13F filing.
Other guru investors include Ken Fisher (Trades, Portfolio) and Richard Pzena (Trades, Portfolio).
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
2. Wells Fargo
Wells Fargo (WFC, Financial) is the third largest bank in the U.S. and a former Buffett investment, before his sale in 2020. Personally, I think this was a mistake, as its stock rose afterward and I believe it still has solid potential despite the company's many problems.
Wells Fargo’s business can be divided into four main segments:
- Investing and Wealth Management.
- Small Business.
- Commercial Banking.
- Corporate and Investment Banking.
Mixed financials
Wells Fargo generated mixed financial results for the fourth quarter of 2022. Its revenue was $19.66 billion, which missed analyst expectations by $375.35 million and dropped by 13.28% year over year. This was driven by a 6% year over year decline in deposits to $89.5 billion, which was a result of consumer outflows. In addition, the company reported an eye watering 57% decline in mortgage originations, which is a negative of the rising interest rate and recessionary environment., A positive was its loans increased by 8% year over year to $73.5 billion.
The company also reported earnings per share of $0.67, which beat analyst estimates by $0.06.
Wells Fargo reported strong net interest income of $13.4 billion in the fourth quarter, which increased by a blistering 45% year over year. This was mainly driven by the rising interest rates.
In terms of liquidity, the company has a CET1 ratio of 10.6%, which was up from the 10.3% in the prior quarter.
Valuation
Wells Fargo trades at a price-book ratio of 1.14.
The GF Value chart indicates a fair value of $48 per share, meaning the stock is “fairly valued” at the time of writing.
Final thoughts
Overall, I believe Bank of America has an edge in terms of its financial performance which looks to have held up much better than Wells Fargo during the recent quarter. I like Wells Fargo and hope it can do well going forward, and it could even be a value opportunity due to investors underestimating it, but Buffett's sale of the stock does still worry me a little, so investors may want to exercise caution.
