When it comes to banking scandals, time heals nearly all wounds. Governments tend to forgive and investors tend to forget.
Investors who bought stock in America’s biggest banks as the last financial crisis was easing, on March 20, 2009 have since gotten very fat gains. Citigroup Inc (NYSE:C) is up 164% since that date, Bank of America Corp (NYSE:BAC) is up 171% and JP Morgan Chase & Co. (NYSE:JPM) is up 180%.
The biggest gains have been at Wells Fargo & Co. (NYSE:WFC), up 214% since the crisis. That includes losses sustained this month after regulators fined it for creating fake checking, savings and brokerage accounts.
Big banks are considered “too big to fail” for a reason. Even the threat of bankruptcy can disrupt the global economy, causing millions in unrelated industries to lose their jobs and governments to fall.
Since the 2008 crisis, U.S. regulators have sought to reform the banking system, requiring more reserves, requiring “stress tests” to assure the biggest banks won’t fail and creating new agencies like the Consumer Finance Protection Bureau to deter cheating.
Concentration of assets among the largest banks has actually increased from 2008, according to SNL Financial, thanks to mergers, some driven by scandal. This has not stopped the big banks from cheating but it should reassure investors that no matter how bad things get now, they can also get better.
This is true in Europe as well. European banks don’t offer governments all the protections American depositors have. But even there, we have a precedent for action. Scandals will continue to take down banks, but once a big bank survives its scandal, it’s time to buy.
Bank Stocks That Can Come Back: Wells Fargo (WFC)
Let’s start with Wells Fargo.
Before this month, Wells was known as the “most honest” of America’s big banks. It had accumulated “only” $10 billion in fines over the last decade, mainly over actions of companies Wells then acquired. CEO John Stumpf was considered honest enough that Warren Buffett had Berkshire Hathaway Inc. (NYSE:BRK.A) continue investing in the bank whose shares he first bought in 1990. Berkshire’s stake in Wells is now about 10% of its common.
That value was threatened after the Los Angeles Times, which had been covering the bank’s pressure-cooker sales culture and resulting customer abuses for years, reported on a $185 million fine from the Consumer Financial Protection Bureau, charging bankers had charged consumers for as many as 2 million phony accounts.
The scandal was even simple enough for Congress to grasp. In televised hearings, House and Senate members took turns attacking Stumpf, calling for his resignation, even demanding the bank be broken up.
Of course, the stock suffered. Shares fell 12.66% in a month. The “price to book,” a measure of the company’s value against the value of its assets, fell from 1.44 to 1.26. The price-to-earnings ratio also fell, to below 11, and the yield shareholders could get rose, to 3.4%. That’s better than the rate savers can get on almost any Wells Fargo product. It’s higher than the rate on many Wells Fargo mortgages.
Still, experts like Richard X Bove, equity research analyst at Rafferty Capital Markets, Garden City, N.Y., say it’s not yet time to step in and buy. He suggested dumping the stock on September 9, and said last week the problems will take years to work out. He also said the scandal means regulators will continue pressuring all banks, and that the industry will have to change how it compensates employees.
Share prices should continue to fall. Even while Stumpf testified, the bank was fined for illegally repossessing the cars of service members. Other agencies, and attorneys general, have yet to weigh-in on the fake account scandal.
Still, Wells stock would have to fall from their present level of $45 to $38 to reach the price-to-book level of JP Morgan Chase. That is a likely bottom. If the price falls below $40 per share, Wells should be a buy.
Bank Stocks That Can Come Back: Deutsche Bank (DB)
Deutsche Bank AG (USA) (NYSE:DB) was the 10th largest bank in the world in March, with almost $2 trillion of assets. It had over $47 billion in revenue last year, yet it opened for trade on September 30 with a market cap of under $16 billion.
That’s because a series of scandals supporting dodgy business practices around the world, the latest a “mirror trading” scandal that allowed Russian oligarchs to get their money out of the country, are coming home to roost.
Recently, U.S. regulators finally caught up with the bank’s involvement in the last decade’s mortgage insurance scandals, blamed for the Great Recession, with the Department of Justice imposing a $14 billion fine, in line with fines imposed on big U.S. banks that were involved in the scandal. Deutsche Bank said it wouldn’t pay.
But the impact of the scandals pales in comparison to the risk inherent in its derivatives book, which contains a reported $45 trillion in assets — 10 times Germany’s gross domestic product — and whose true value remains unknown. When U.S. hedge funds, which often deal in derivatives, said they were closing their accounts at the bank, fearing its solvency, the shares plunged again, taking U.S. and European markets down with them.
CEO John Cryan sent a memo to employees, blaming “speculators” for the stock fall, insisting the bank has the strength to weather its problems, but it reminded some traders of what U.S. banks said just before they collapsed in 2008.
So what is the bank worth? The fear is that the $14 billion fine is equivalent to the bank’s market cap, and it may be unable to sell enough new stock to pay the fine under German law.
Still, bank shares rose sharply on September 30. Investors know about forgive and forget. They may be early on this trade but chances are better than 50-50 they have it right.
Bank Stocks That Can Come Back: Bank of America (BAC)
Investors wanting to know how fast a bank can come back from scandal should look first at Bank of America.
Bank of America, which took that name after NationsBank of North Carolina bought California’s Bank of America in 1999, got many of the worst assets during the 2008 financial crisis. During 2007 and 2008, it acquired both Merrill Lynch and Countrywide Financial, making it the leading servicer of mortgagers just as that market imploded, and a big holder of the Credit Default Swaps featured in the movie The Big Short.
Bank of America received over $25 billion in the 2008 bailout, $20 billion of it directly, but eventually paid $91.2 billion in fines and penalties for actions taken before the bailout.
Since the stock bottomed in late 2011 at about $5 per share, however, Bank of America has nearly tripled in value, opening for trade Friday at $15.26. It continued to pay a dividend throughout the crisis, although that remained a nominal 1 cent per share until 2014. It’s now at 7.5 cents quarterly.
Most of those gains, it should be noted, came in the first two years after the smoke cleared, and this is true for the forgiveness trade generally. The shares hit a peak of $17.90 in late 2014. But the stock chart is now favorable, writes our Serge Berger, and it is reappearing on buy lists.
Bank of America is the second-largest U.S. bank by assets, at $2.15 trillion, and while the Wells scandal may cause it to reduce employee incentives to sell, or even close branches, emphasizing electronic banking instead, such moves could save money and actually add to its profitability in the future.
Bank Stocks That Can Come Back: HSBC (HSBC)
HSBC Holdings Plc (ADR) (NYSE:HSBC) is based in London but, as the name implies, the bank originated with Britain’s China trade, as Hongkong and Shanghai Banking Corp.
Many of HSBC’s sins occurred in Switzerland, where its Private Banking unit was implicated in money laundering and tax evasion scandals. By 2015 it faced 10 different inquiries into the activities of the unit. These included criminal investigations.
HSBC was also implicated in the 2012 LIBOR scandal, in which a group of international banks was accused of fixing rates charged for interbank lending, rather than allowing a free market to set the rates. It was also accused in a scheme to fix the prices of precious metals in 2015.
All this took a heavy toll on the stock, which fell from almost $60 in 2013 to a less than $30 in June of this year, which came despite a dividend payout of $1.05 per share in March and 50 cents the rest of the quarters. But memories do fade. Near the end of September, the stock was trading at above $37. Even at that price, its dividend yield is a whopping 6.8%.
The shares could be headed higher.
Bank Stocks That Can Come Back: JP Morgan Chase (JPM)
JP Morgan Chase has, through Wells Fargo’s missteps, taken back its position as America’s leading big banks, at least when it comes to ethics.
Given the bank’s history, this is a remarkable turnaround.
Nearly all of the banking industry’s sins have, at one time, touched on JP Morgan Chase and its predecessor companies, which include the banking empires of J.P. Morgan and David Rockefeller, among others. During the 2008 financial crisis it acquired both Bear Stearns and Washington Mutual. It paid over $2 billion in fines and penalties to cover its part in the Bernie Madoff scandal.
The bank’s $2.4 trillion in assets have helped cushion the impact of its fines, which came to over $38 billion between 2009 and the middle of 2015, not including over $300 million paid in December to cover conflict of interest charges.
Yet the stock has moved up fairly consistently since early 2009, delivering a return of 120% in just the last five years, not including dividends that now come to 48 cents each quarter. The dividends are easily covered — the bank earned $6 per share in 2015 alone.
Much of the credit for that record belongs to Jamie Dimon, who has been CEO since 2005. Dimon remains on the job, despite a bout with throat cancer, the loss of his parents and the death of close friend and investment banker Jimmy Lee. Over half the analysts following the stock now have it rated as a buy.
They have it right.
Bank Stocks That Can Come Back: Barclays (BCS)
Of all the rogues in this gallery, Barclays Plc (ADR) (NYSE:BCS) has done the worst for shareholders since 2009, and now trades for 12% less than it did five years ago.
Barclays was at the heart of the LIBOR scandal, which resulted in a $450 million fine, and was said to have a “toxic culture” as recently as 2013. It was hit by a fine of 1.53 billion pounds for its role in helping fix foreign exchange rates. Criminal investigations of its activities are expected to last until early next year.
Because it fought the charges against it so strenuously, Barclay’s punishment by the market was also delayed. The shares’ value fell by more than half between August, 2015 and July of this year, although since bottoming in June they have finally risen by over $2, to a recent price of $8.70.
Financial results have yet to recover. It remains, however, the 16th largest bank in the world, with $1.8 trillion in assets in March. Those assets now support a market cap of under $38 billion.
If Barclays can just stay out of trouble, it will probably do very well for shareholders. Once bad banks admit guilt and get punished, investors tend to be forgiving. Selling money for more than you pay for it remains a very good business.
Dana Blankenhorn is a financial journalist who dabbles in fiction, his latest being The Reluctant Detective Travels in Time. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares of WFC.
