by Dan Burrows | September 17, 2013 1:11 pm
It’s been five long years since Lehman Bros. blew up and the nation’s biggest banks still haven’t put the ordeal behind them.
True, recent midyear stress tests revealed more-than-adequate capitalization levels — but then, the fact that bank stocks still have to model for doomsday scenarios isn’t very reassuring.
At the same time, Bank of America (BAC) just got kicked out of the Dow Jones Industrial Average because its share price is too low — a legacy of the great crash.
And on Tuesday, JPMorgan Chase (JPM) — once thought to be the best-managed bank for the way it sailed through the financial crisis — reportedly has agreed to pay $800 million in fines to settle the London Whale trading fiasco, which cost the bank $6 billion and counting.
More importantly, JPM admitted wrongdoing, which likely will only add to the pile of litigation and fines it’s facing for peddling subprime mortgages and other shenanigans.
Kind of makes you wonder why anyone would want to own shares in the nation’s biggest banks.
With that in mind, we took a look at JPM, the largest bank by assets, and Wells Fargo (WFC), the largest bank by market cap, to see whether either is worth the risk.
For all its woes, JPM has been a respectable performer for the year-to-date. Shares are up 21% and beating the S&P 500 by just more than 1 percentage point.
It’s also proven to be a good stock to buy on selloffs following ugly headlines. Shares in JPM cratered last year when the London Whale losses were first disclosed. If you had bought at the point of maximum panic in early June 2012, you would be sitting on a gain of more than 70% by now.
Partly that’s because of the bank’s extremely diversified business model. JPM easily topped Wall Street estimates last quarter — posting near-record profits — despite a slowdown in its retail banking business.
As much as investment banking, trading and asset management keep getting JPM into hot water with regulators and prosecutors, they also keep coming to the rescue when it comes to growing the bottom line.
Finally, the market seems to be discounting the bad news and risks associated with JPM. Shares trade well below their own five-year average on a forward earnings basis, according to data from Thomson Reuters Stock Reports.
WFC isn’t just the nation’s biggest bank stock by market cap — it’s also by far the largest mortgage lender.
That was an enviable position to hold when record-low interest rates drove a massive boom in refinancing activity. But now that rates are on the rise, refinancing has all but dried up and mortgage originations are slowing down.
That hasn’t much scared the market, however. Shares in WFC are up 25% for the year-to-date, beating the broader market by 5 percentage points.
The outperformance is being helped by stabilization in net interest margin (NIM) — the difference between what a bank pays for deposits and charges for loans. Record-low interest rates have caused all banks’ net interest margins to decline steadily for years. Indeed, it has been the No. 1 worry for WFC investors — and, at long last, the bank’s NIM is poised to start rising again.
It also doesn’t hurt that, like JPM, shares look pretty cheap, trading at a significant discount to their own five-year average on a forward earnings basis.
If you’re betting on the financial sector, ideally you would own both bank stocks — plus a whole lot more — as part of a diversified portfolio (say, through a financial sector exchange-traded fund.)
But if you had to chose between two, WFC looks like the better bet. That’s because rising interest rates are more likely to help WFC — and hurt JPM.
True, interest-rate uncertainty has damped demand for loans throughout the industry, but at least WFC is poised to start benefiting from its net interest margin. Meanwhile, the decline in margins at JPM has actually accelerated in sequential quarters.
A return to more normal margins will make WFC’s boring old business of taking deposits and making loans much more profitable. JPM’s retail banking operation will likewise benefit eventually, but at this point, it looks to be behind the curve.
Lastly, WFC’s simpler business model — and JPM’s seemingly endless run of regulatory, litigation and headline risks — easily tip this choice in Wells Fargo’s favor.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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