Seven Financial Stocks Poised to Profit
10/30/2009 9:25 am EST
As banks move away from traditional banking to goose their profits and shore up their capital ratios, a handful of global players are getting into position to fill the void.
Like Mother Nature, Mr. Market abhors a vacuum.
If the big US banks are less interested in what you and I would call traditional banking, if many regional US banks are cutting back on lending to shrink their balance sheets so that they don't have to raise new capital, if some of the biggest overseas and US financial institutions are exiting entire countries, it's only logical to assume that somebody is going to fill the vacuum.
If you're an investor interested in making a long-term profit in the financial sector, the only thing you want to know is who.
I'm going to give you six names to research and tuck away until you can buy them at reasonable prices. The rally in financial stocks since March 9 is no more sustainable than any early lead of mine would be in Sunday's New York Marathon. And sometime in 2010, you'll get a chance to buy—at better prices—the best names in the post-crisis financial sector. You'll just have to be ready.
I sketched in part of the vacuum that's forming in the traditional banking business in my October 27 column, "Why Big Banks Hate Banking." I explained that the biggest and most successful banks post-crisis, such as JPMorgan Chase and Goldman Sachs, are bringing in the majority of their revenue and an even bigger percentage of their profits from such activities as trading, rather than core banking functions like lending to businesses and consumers. I argued that the example of these big banks—and their success at generating profits when most of their peers are still producing red ink—will drive that whole tier of banks toward trading and away from the lending model.
Cutting Back on New Lending
Meanwhile, it's not as if most smaller US banks—smaller than JPMorgan Chase doesn't necessarily mean small—are embracing the opportunity to expand their traditional banking businesses. Most of them are still busy selling existing loan portfolios, if they can, and reducing the size of their loan portfolios by cutting back on new lending.
The motivation here is pretty simple: Banks such as Comerica, Fifth Third
Bank, KeyCorp, Regions Financial, SunTrust Banks, and Zions Bancorporation all
need to "fix" their capital-to-lending ratios, either by raising more capital in
the public markets or by shrinking their lending portfolios.
The ratio problem gets worse every time these banks issue quarterly reports fessing up to big credit losses and announcing that they're going to put more away in reserves against future losses. Because capital is still tough and expensive for banks to raise, especially if you're a bank still showing a rising tide of credit losses, cutting back on lending is by far the most attractive solution.
These aren't small banks. In stock market capitalization, they range from $9.6 billion for SunTrust to $2.1 billion for Zions. They're big enough to have filled a good part of the void in the traditional banking markets caused by the move toward trading by the country's biggest banks. But their own need to shrink their loan portfolios is making them not the solution but part of the problem.
A Greater Retreat in Europe
I don't mean to give the impression that this problem is limited to the United States. Banks' retreat from banking may be even greater in Europe, where market forces and European Union regulators have combined forces to create a banking sector vacuum.
On the market side, you have companies such as HSBC that have decided to wind down their home mortgage business in the US after generating more than $17 billion in losses.
On the regulatory side, the European Union, determined that banks that have taken government money shouldn't get a competitive edge from the bailout (as Goldman Sachs has in the US from government guarantees), is busy forcing banks to shrink their balance sheets or to lop off whole business units. So Germany's Commerzbank is being forced to shrink its balance sheet by 45%.
ING Groep will be required to split up its banking and insurance businesses and then sell the insurance unit, and to dispose of its ING Direct US Internet banking business with its $90 billion in assets. (For more on ING, see my new blog post.)|pagebreak|
This looks like just the beginning, too. European Union regulators have yet to rule on reorganization plans submitted by Royal Bank of Scotland Group and Lloyds Banking Group. Before the Oct. 26 ING breakup announcement, the consensus among banking analysts in the United Kingdom was that Royal Bank of Scotland would have to shrink its 30% share of the small business lending market in the United Kingdom and reduce its balance sheet by disposing of $425 billion in non-core assets.
In light of the ING decision, the thinking now is that Royal Bank of Scotland may wind up doing even more.
So which banks have the potential to fill the vacuum? Here's a preliminary list of useful suspects for further research:
- In the US, look at US Bancorp (NYSE: USB). According to Deutsche Bank, US Bancorp is one of the
few US banks likely to start growing its loan portfolio—not sometime in 2012,
but now. Average loans grew by 3.1% in the third quarter, excluding acquired
loans. The Federal Deposit Insurance Corp. has looked to the bank to acquire
troubled banks and their assets. US Bancorp has picked up $12.5 billion in
deposits through this route in the last year. There's even a chance the bank
will increase its current five-cent-per-share dividend at the end of 2009 to
maybe ten cents. The bank cut its dividend from 42.5 cents a share in the
first quarter of 2009.
- In Canada, look at Toronto-Dominion (NYSE: TD). The bank has used its heavily regulated Canadian market
as a base for moving into banking (through the acquisition of Commerce
Bancorp) and discount brokerage services in the US. And on a related note, I'd
also look at Canada's Manulife Financial (NYSE: MFC) to fill the void in China and Asia left by the
withdrawal of American International Group and ING from that insurance
- In China, look at HSBC (NYSE: HBC). After its debacle in the US mortgage market when the
company spent $17 billion on an acquisition that then produced $17 billion in
losses, the company has refocused on its historic roots in Asia. The company's
CEO has moved to Hong Kong, and HSBC is pursuing a listing on the Shanghai
- In Spain, look at Banco Santander (NYSE: STD). The company acquired US bank Sovereign in 2008—not the
best of timing—to break into the US market. Through its acquisition of
troubled Alliance & Leicester and Bradford & Bingley in the United
Kingdom, Santander became the third largest bank in that country. (And, oh,
Santander is the largest bank in Latin America.)
- In Africa, look at Standard Bank Group (OTC: SBGOY). One of the four largest banks in South Africa,
Standard does business in 38 countries. The Industrial and Commercial Bank of
China owns 20% of Standard's shares. Standard also owns Liberty Life Holdings,
an insurance company.
- In the United Kingdom, look at Standard Chartered (OTC: SCBFF). The bank, based in London, does business across Asia, Africa, the Middle East, and Europe. It was in a strong enough position to offer to buy the Asian assets of Royal Bank of Scotland, although the deal fell apart over differences in valuation.
As I said at the top, I wouldn't buy any of these now after this huge—and premature—rally in the financial sector. You'll get a better chance to buy in 2010, but this gives us a place to start our research. I'll be filling in the details and offering some new candidates as the global banking crisis continues to reshape the sector.
At the time of publication, Jim Jubak owned shares of the following companies mentioned in this article: HSBC and Toronto-Dominion.
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Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.