In 1999, Congress repealed a piece of Depression-era legislation commonly referred to as the Glass-Steagall Act that was intended to reduce risk at banks by limiting investment activities. In the wake of the financial crisis, this move has taken a lot of heat — and not without reason. After all, the repeal of Glass-Steagall enabled commercial lenders like Citigroup to dip into the kinky investment acronyms we have come to despise — CDOs, SIVs and other items that resulted in huge losses at Citi and others. Obama’s proposal would prevent commercifal banks from ever taking such bets again and putting depositors and the credit market at risk. The president has also proposed limits on financial mergers, in an effort to prevent the bailout of another bank that is “too big to fail.”
Let’s be honest, though. This move is undoubtedly driven by election-year politics as much as the financial crisis and big banks make an easy scapegoat for Democrats. Just look at Obama’s other proposal — a “Financial Crisis Responsibility Fee” that is expected to raise $90 billion over the next 10 years, with around 60% of the revenue coming from the 10 largest financial firms. Clearly the White House is looking to mitigate fallout from the big bonuses and profits posted recently by financial companies that took taxpayer cash.
What Does This Mean for Investors?
Well, two main things really: It will force the big banks to get smaller, and it will allow the smaller banks to thrive.
Right now, Bank of America (BAC), Citigroup (C), JP Morgan Chase (JPM) and Wells Fargo (WFC) are the titans of the financial sector. Not only were these firms “too big to fail” before the financial crisis, they are actually even bigger now that competitors have been dropping out. Consider that Wachovia was the fourth-largest bank holding company in the United States based on total assets before its forced marriage with Wells Fargo in December 2008, or that BAC’s acquisition of Merrill Lynch made the company the world’s largest wealth manager. The White House clearly wants to stop this trend and force banks to get smaller by splitting into investment and commercial entities, and by prohibiting major mergers. If Obama’s plan is enacted, the going for major financial companies just got even tougher.
The Big Opportunity for Investors
For a long time, big banks have focused on their investment divisions because that’s where the money is. After all, why would JP Morgan Chase kill itself making dozens of small business loans when it posted a record profit $11.7 billion for all of 2009 thanks in large part to its investment banking operations? Regional banks just can’t compete with profits like that. But if Obama forces banks to separate their investments and hedge funds from commercial operations, the playing field has suddenly been leveled. In fact, since the bigger banks have been widely criticized for high fees and poor customer service for smaller clients, there is reason to believe a rebirth of regional banks is likely. If Obama gets his way, this could present a huge opportunity for investors.
Whatever happens, one thing is clear: The White House has declared war on the big banks, and the financial sector will remain in turmoil as a result until some truce is reached. “Much of the turmoil of this recession was caused by the irresponsibility of banks and financial institutions on Wall Street,” President Obama said in a radio address on Jan. 16. “These financial firms took huge, reckless risks in pursuit of short-term profits and soaring bonuses.”
Those are fighting words. And if the president has his way, it’s a fight the big banks are going to lose.
Four Bank Stocks Boosted by Glass-Steagall 2.0
To capitalize on this trend, I advise investing in fundamentally superior regional banks. Here are four such banks I expect to do very well in the coming months as a result of these planned changes in the financial industry:
Prosperity Bancshares (PRSP) — Prosperity is a slightly larger outfit than the other banks listed below, but not by much. The company has a market cap of under $2 billion and operates about 200 full-service banking locations in and around Texas. However, it’s what PRSP does with its small operations that makes all the difference. The stock recently hit a 52-week high in late January thanks to a blowout earnings report. The company has grown its profits for each of the last four quarters and has topped Wall Street expectations every time. That’s a track record of success hard to come by in any industry, let alone the financial sector.
Great Southern Bancorp (GSBC) — This thinly traded regional bank only sees a volume of about 30,000 shares a day, but is a great buy because it has stuck to low-risk consumer banking in the Missouri area and weathered the credit crisis very easily. The company’s three previous quarterly reports boasted earnings surprises of 760%, 2,300% and 855% — so there’s plenty of reason to expect this stock to keep flying high in 2010.
CNB Financial (CCNE) — CNB is an even smaller outfit, with a volume of only a few thousand shares a day and only a few dozen full-service branches around Pennsylvania. But remember, smaller is better under the new rules — especially when the company is run right. My proprietary stock screening tool gives this company top marks for sales growth, earnings growth and earnings momentum. What’s more, you get a nice dividend of 66 cents per share for owning this very affordable stock.
National Bankshares (NKSH) — Serving southwestern Virginia, this small regional bank shares the low volume and small market cap of the previous two picks. But it also shares the tremendous growth potential and low-risk philosophy that makes the other pair great buys. NKSH has been consistently profitable even during the depth of the recession thanks to loan losses of just 0.77%. Shares of this bank are actually higher now than at any point in the last three years. That’s a sign of a bank that has weathered the financial crisis just fine and is doing business the right way.
I expect these four banks to win out big-time in the months ahead. But be careful if you decide to purchase shares since a little volume can really cause these tiny picks to go flying. I strongly recommend protecting yourself by using a limit order within 25 cents of the previous day’s close. Otherwise, you could overpay for shares of these stocks, and hurt yourself and other investors.
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