While the banking sector is one of the weakest in today's market, it could be a good time for contrarian investors to scoop up bank stocks.
As coronavirus continues to spread across the globe, the economic impact has become undeniable. It’s still unclear whether the impact from the world-wide outbreak will be short lived or long-term, but some sectors won’t be able to survive either scenario.
The financial sectors is particularly vulnerable, but that doesn’t mean investors should avoid bank stocks all together. Instead, current conditions could create a buying opportunity for those with a stomach for risk.
Long before coronavirus was chipping away at the global economy, McKinsey warned that the financial sector wasn’t prepared for an economic downturn. The consultancy warned that rising competition from fintech coupled with rising costs has left the sector totally unprepared for an economic downturn.
At the time, the downturn McKinsey was talking about was expected to be far more gradual.
Last year, many were expecting to see far more consolidation within the financial sector but very little materialized. Valuations among financials were still relatively low and the Trump administration’s policies were considered accommodative for consolidation— the environment looked perfect for flurry of M&A activity.
But banks were unwilling to give up their individual identities unless absolutely necessary. With interest rates expected to remain constant or rise and the economy chugging along, banks didn’t feel the urgency to merge as some had predicted.
Now, it’s a different story. The Fed’s interest rate cut is largely expected to be the first of at least two and banks are struggling to turn a profit.
Typically, banks generate over half of their net revenue by net interest income— the difference between the interest the bank is charging borrowers and the interest the bank itself pays for its supply of money. When rates are low, banks are earning less money on every loan they make.
So, the doomsday scenario is bad for banks, but it could be good for investors.
Piper Sandler’s Robert Albertson says the fact that bank stocks have taken a nosedive could be a buying opportunity. In his view, the mass exodus from big banks is overdone:
When there’s a global discontinuity of this magnitude, financials always get hit the hardest. But it’s not fundamental. It’s psychological. So if you’re looking for a trade coming out of it and you feel like we’re seeing not the end so much, but the diminution of the crisis, financials is where you want to go.
Albertson is probably right, big banks are unlikely to go under. Long-term investors stand to benefit from the market’s panic if they can stomach some volatility.
The best bet among big bank stocks is probably Morgan Stanley (NYSE:MS) because unlike many of its peers, the company doesn’t depend heavily on low-cost deposits. Morgan Stanley’s solid Q4 results and planned E Trade Financial acquisition should put it in a solid position among bank stocks once the coronavirus hangover has cleared.
Investors with an appetite for risk might find it useful to evaluate potential takeover targets in the financial sector. Times are about to get exceedingly tough for regional banks, making them prime acquisition candidates.
Regional banks with assets over $50 billion are the most likely to merge because of FDIC regulations. Banks with over $50 billion in assets are subject to tighter regulations, so those below that threshold are likely to avoid entering that bracket.
Beyond that, bank stocks with low return on equity are likely to explore potential mergers as they will benefit most from the cost synergies that consolidation offers.
Looking at that criteria, there are several regional banks that look likely to be exploring a potential merge:
|People’s United Financial||PBCT||7.23%||11.06|
|Citizens Financial Group||CFG||8.46%||7.35|
|Regions Financial Corp||RF||10.28%||8.63|
All four of these bank stocks sport a P/E ratio below 12 and have some of the lowest ROEs in the industry making them good M&A candidates.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com. The above should not be considered trading advice from CCN.com. As of this writing, the author did not hold a position in any of the aforementioned securities.
This article was edited by Sam Bourgi.
Last modified: March 8, 2020 4:54 PM UTC