3 Bank Stocks Worth Your Attention

07/06/2011 12:30 pm EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

Bank stocks have been one of the worst performing groups during the first half of 2011, but several of them now represent very good long-term values, writes George Putnam III of The Turnaround Letter.

While there is still the risk that more negative headlines will keep them under pressure for the short term, bank stocks have been beaten down to levels where they look very cheap.

Below we identify the stocks of a few large banking companies that we believe have very attractive long-term appreciation potential.

Investors have a number of concerns and questions about the sector right now: How will increased regulation under Dodd-Frank and other laws affect future prospects? Have the real-estate loan problems from 2008 really been resolved? How will US banks be affected by the latest Greek crisis?

Of course, no one has the answers to these questions and others, and since investors hate uncertainty, they have reacted by dumping bank shares. We believe that this short-term focus has obscured a longer-term opportunity.

The big banks have cut back on risky practices (either voluntarily, or by regulatory decree) and re-focused on their core businesses. Basic business banking may be less sexy than re-packaging subprime mortgages, but in the long run it is less volatile and more profitable.

Many of the large US banks are now trading well below their book value. Historically, when times are good, bank stocks have traded at two or more times book value. It could take a couple of years for bank valuations to get back to those levels, but if they do, the appreciation in the stocks will be dramatic.

Moreover, in the meantime, shareholders could be rewarded with increasing dividends and stock buybacks. Coming out of 2008, the regulators severely restricted dividend payments and stock repurchases by the banks, but the government is gradually loosening these restrictions.

Bank of America (BAC) has powerful franchises in retail and commercial banking, credit cards, mortgage lending, and investment banking.

Each of these areas—and particularly the latter two—have caused the bank significant headaches since 2008, but it's beginning to put those problems behind it. The recent mortgage settlement is another step in the right direction. Eventually, the bank’s massive scale should generate huge profits.

Citigroup (C) has a similarly broad reach, but on a global scale. The company’s colossal ambitions almost brought it down in 2008 and 2009.

But now, as it becomes leaner and more focused by selling off non-core assets, it could finally become the profit machine envisioned by the now-deposed empire-builders.

Fifth Third Bancorp (FITB) jeopardized its traditional strength in the Midwest by expanding into Florida at exactly the wrong time.

The company has gone back to basics, and still has a strong franchise in its core markets. Earlier this year, it paid back the last of its Federal crisis funding, and it increased its dividend. We may have been a little early in recommending the purchase of Fifth Third, but we definitely still like it.

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