The Best Banks to Invest in

07/27/2010 10:30 am EST


Jim Jubak

Founder and Editor,

The post-crisis financial landscape may be confusing to investors, but it offers more banking models to choose from—including one that seems poised for long-term growth.

If you were designing a bank now, from scratch, for growth and maximum profits, what kind of bank would you build?

Bank earnings this year—from the biggest and most aggressive investment banks such as Goldman Sachs (NYSE: GS) to the do-everything behemoths such as JPMorgan Chase (NYSE: JPM), to the lending-oriented banks such as U.S. Bancorp (NYSE: USB), to the specialist banks—don't give a single definitive answer. It's hard to tell whether the old models are in need of serious overhaul or just taking a breather, and there are serious doubts about the future profitability of many classic banking activities.

And I think that's healthy—even if it makes life hard for investors. The clear consensus on what a bank should be if it wanted to maximize growth and profits was, it turns out, one of the great weaknesses of the banking system before the financial crisis. Too many banks had decided to be the same kind of bank. And that left the industry exceedingly vulnerable to disruption and failure.

For the moment, at least, investors are free again to look for the best bank among many styles of banks, rather than investigating which bank matches up best with a single model for success.

Here's how the landscape looks to me right now and the names of some interesting banks, of different models.

Before the financial crisis, bank CEOs thought they had a clear answer to what the best bank would be like. They wouldn't worry too much about building a big base of depositors; it was easy to raise all the money a bank needed to finance its lending and other activities in the financial markets. They'd build trading desks that traded for clients, of course, but that also put the bank's own capital at risk in proprietary trades. And they'd work to build up investment banking activities ranging from underwriting stock and bond offerings to selling packages of securitized mortgages, credit card receipts, and car loans. They would also engage in complex derivatives that let clients bet on the direction of financial markets or let them hedge the risk of complicated trading strategies.

The bank these CEOs had in mind was about as far from Frank Capra's Bailey Building & Loan as possible.

But the financial crisis took some of the edge off that model.

For one thing, it demonstrated that the banks built on that model had put everything in one basket. They needed functioning financial markets, not just to raise capital, but also to roll over the existing debt that provided current capital. Gains from trading for a bank's own account were dependent on being able to figure out the direction of the markets, and revenue from trading for clients' accounts were dependent on the willingness of those clients to be in the markets at all.

The model left banks with strikingly few alternatives in a crisis. At the end of "It's a Wonderful Life," the building and loan's depositors ride to George Bailey's rescue. In the recent crisis, banks built around the pre-crash model had no one to turn to but governments and reluctant taxpayers.

Here's a quick rundown of the various banking models and their prospects.

Article Continues on Page 2


The Investment Bank/Trading Model: Not Dead Yet

It's not clear how damaged this model is. In the first quarter of 2010, it looked like it was back on top: Trading and investment banking revenue soared while commercial and consumer lenders were still drowning in a sea of bad loans. In the just-completed second quarter, trading and investment banking revenue fell. The infallible traders of the first quarter turned out to be no better than the average investor at making a profit in a volatile and unpredictable market. Even the banks, such as Morgan Stanley (NYSE: MS), that had looked like they'd had successful trading quarters, wound up making a good part of their trading revenue out of accounting gimmicks based on the price of their own debt.
But the biggest long-term threat to the trading and investment banking model as adopted by US banks comes from the shift in global finance toward the world's developing financial markets. The largest stock offerings of 2010, for example, haven't been in New York or London, but in São Paulo, Hong Kong, and Shanghai. The big US-based pre-crisis powers such as Morgan Stanley haven't been shut out of these deals, but they've had to share them with "local" banks such as HSBC (NYSE: HBC) in Hong Kong and Itaú Unibanco (NYSE: ITUB) in São Paulo. In one example of growing heft, Itaú climbed past Goldman Sachs in 2009 to become the fourth-largest underwriter of overseas bond sales for Brazilian companies.

This global shift in what I'd call not financial power but financial weight puts the big US banks that had adopted the investment banking/trading model at a disadvantage in two more ways:

  • First, as a result of the financial crisis, many of the US banks that had built up the biggest overseas networks of offices and contacts either sold off those units or scaled them back
  • Second, many of the US banks built on the investment banking/trading model now can't match the deposit-gathering power of either big (Banco Santander (NYSE: STD) and HSBC) or smaller (India's HDFC (NYSE: HDB)) overseas banks.

Once the banks built on the investment bank/trading model have their bounce—and some of them clearly have—investors need to recognize that the US banks that adopted this model face some of the toughest challenges in the banking sector. Indeed, my favorite banks built on this model are not US banks. I much prefer overseas banks such as Itaú Unibanco, HSBC, and Banco Santander.

Regionals: Loans and Deposits Still Matter

You could see that in the regional bank earnings announced July 22 and in the earnings announced the day before by US Bancorp, which has emerged as the fourth-largest US bank during the crisis.

These banks lagged the investment banks in 2009 and in the first quarter of 2010 because the latter saw a recovery in revenue from investment and trading well before the lending-oriented banks saw any improvement in either bad loans or loan volume.

Now it looks like the roles are reversed: Trading revenue has faltered just as loan portfolios have started to improve.

PNC Financial Services (NYSE: PNC), for example, reported earnings per share of $1.47 for the second quarter. That was 19 cents a share above the Wall Street consensus projection. Revenue climbed almost 3% from the second quarter of 2009. That beat the projection of $3.78 billion by 3.4%.

The big story was the stabilization in the bank's loan portfolios. Non-performing assets fell by $465 million in the quarter. There's still quite a way to go, though: The bank finished the quarter with $6.1 billion in non-performing assets.
Change the names and the story remains the same at Fifth Third Bancorp (Nasdaq: FITB) and KeyCorp (NYSE: KEY). Fifth Third reported its first profit since the fourth quarter of 2007 as non-performing loans fell by 8% from the first quarter. Keycorp reported its first profit in more than two years; non-performing loans fell by $362 million in the quarter.

My two favorite banks in this part of the industry are US Bancorp, which reported earnings July 21 (for the details, see this post on my Web site), and Wilmington Trust (NYSE: WL). Wilmington is still very risky—its recovery seems to be lagging some similarly constructed banks—but the bank's July 23 earnings report definitely showed signs that it was catching up.

Small and Special: Long-Term Potential

So why do I like US Bancorp and Wilmington Trust among the banks that still follow a traditional mix of lending and deposit gathering? Because they've built up big fee-based wealth management businesses, and, as the country ages, that's a piece of the banking industry that will become increasingly profitable.

But if you really want exposure to this revenue and profit stream, you need to look at smaller banks, where wealth management is a bigger part of revenue.

Bank of Marin Bancorp (Nasdaq: BMRC), for example, reported second quarter earnings of $3.3 million, up 6.5% from the second quarter of 2009. But non-interest income—what the bank earns on its for-fee businesses—did somewhat better than the bank as a whole. Non-interest income grew 18.2% from the second quarter of 2009, to a total of $1.5 million, and equaled 45% of the bank's income for the quarter. The biggest contributors to that growth came from higher merchant interchange income and higher wealth management service fees, the bank said in its earnings announcement.

If that kind of banking model tickles your investing bone, take a look at Bryn Mawr Bank (Nasdaq: BMTC). Assets under management on June 30, 2010, in the bank's wealth management division were up $3.1 billion, or 37%, from a year earlier. Revenue from that division had climbed almost 8% from the second quarter of 2009.
You can invest in any of these three models or concentrate in just one of them. I think that the stocks of the traditional lending/deposit-gathering banks are the most timely, that the stocks of the big investment banking/trading are the most volatile, and that the stocks of the wealth management specialty banks are the least risky in the long run.

At the time of publication, Jim Jubak owned shares of the following company mentioned in this column: Bank of Marin Bancorp.

See the complete Jubak’s Picks Portfolio here

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

Related Articles on STOCKS

Keyword Image
S&P 500: No Pain No Gain
1 hour ago

The E-mini S&P 500 needs to fall below 2800 before the bulls will buy again. It might test the J...

Keyword Image
Prepare For Market Storms
08/16/2019 6:00 am EST

Too many traders appeared unprepared by the recent, relatively mild equity market correction warns L...