Bank of America Corp (NYSE:BAC) shareholders, give yourselves a pat on the back.
BAC stock since the beginning of 2016 is up 34%, its best annual performance over the past four years. Once investors got over their worries about corporate lending, interest rates, revenue shortfalls and other banking concerns earlier in the year, bank stocks took off like a rocket with BAC leading the charge.
Can the good times continue?
“We say 2017-18 might be “Goldilocks” years because credit costs are likely to remain low, expenses have been tamped down and will likely stay that way, but revenues seem poised to get a lift,” Oppenheimer analyst Chris Kotowski recently wrote. “The stocks are no longer cheap, but not expensive either. Our favorite names remain Bank of America, Citigroup, CIT Group and Goldman Sachs Group.”
Compared to the S&P 500, reasons Kotowski, bank stocks are still cheaper with a relative P/E ratio of 77%. His advice: Let the bet ride.
Long-term, he’s probably right. But with rising betas at the big banks, investors might want to give pause to ponder if a significant correction is looming.
Independent strategist Peter Kenny recently told Barron’s Ben Levisohn that unless some sort of catalyst appears, such as an interest rate hike, bank stocks are facing a rough patch in the short-term although the future is generally bright.
Bank stock betas began the year around one with volatility approximately the same as the market itself. Now, KBW bank analyst Frederick Cannon told Barron’s, bank betas hover around 1.4, meaning they’re 40% more volatile than the general market. If stocks correct in 2017, BAC shareholders will definitely feel it.
I don’t have a crystal ball and neither do analysts. That’s why Cannon suggests investors consider selling high-beta bank stocks and rotating into lower beta stocks.
BAC stock has a current beta of 1.61; that’s high. U.S. Bancorp (NYSE:USB) has a current beta of 0.84; that’s low. If you believe in beta and what it tells us about future trading patterns, the rational thing to do at the moment is to sell BAC stock and buy USB.
USB might be a lot smaller than BAC in terms of assets ($2.2 trillion vs $438 million) but it has a number of important factors working in its favor.
- Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B) owns $4 billion worth, or about 1%, of USB’s stock. Sure, it’s not nearly as big as Warren Buffett’s position in Wells Fargo & Co (NYSE:WFC), but with all the turmoil surrounding WFC, he probably wishes his position in USB was bigger.
- U.S. Bancorp is the most profitable bank in America, with return on equity of 14.3% and return on assets of 1.4%. Wells Fargo is number two; Bank of America doesn’t even make the list.
- USB generates almost as much noninterest income — $7.1 billion in the first nine months of 2016 through Sept. 30, a 5.8% increase year-over-year — as it does from its credit-related products, providing very diversified revenue streams.
- Analysts expect its overall loan portfolio to grow by 4%-6% in the next year so it’s doing well in both areas of its business.
- USB’s wealth management business continues to become a more important contributor to the bank’s net income. In Q3 2016, its earnings grew 58.3% year-over-year to $95 million and by 56.6% to $274 million in the first nine months of the year.
- Its consumer and small-business banking business continues to be a big driver of growth. In the third quarter, the segment’s revenues grew by a healthy 7.6% to $1.9 billion, or 35% of its overall revenue.
There’s a lot to like about U.S. Bancorp, not the least of which is its 2.2% dividend yield, 90 basis points higher than BAC.
Should the banking waters get stormy, USB is a friendlier port in my opinion. Alternatively, look at the Canadian banks whose betas are lower and profitability higher.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
