About Bank Stocks

One of the major components of the stock market in the United States has always been the stocks of publicly-owned banks. Unfortunately, bank stocks have had a cataclysmic fall in the last few years undermining investor's faith in stocks that were once considered blue-chips. Stocks like JP Morgan Chase, Bank of America and Wells Fargo Bank have lost billions of dollars of shareholder equity as their shaky lending portfolios have been exposed to a turbulent credit market. It is not only the nation's largest banks which have suffered. Even today, after nearly two years of closing troubled banks, the FDIC still has an estimated 775 banks remaining on their list of "problem" institutions through the first quarter of 2010. Sheila Bair, FDIC Chairman, stated recently, "The banking system still has many problems to work through, and we cannot ignore the possibility of more financial market volatility". It wasn't always this dire for banks and their stock prices. Before the financial crisis that began in the summer of 2008, bank stocks were considered one of the sectors of stocks that provided more stability, consistent dividend income, and earnings growth potential than other more volatile sectors. However, that perception has been altered, perhaps for a very long time, by the rapid decrease in the prices of bank stocks in 2008 and 2009. The main culprit for the decline of bank stocks was the enormous number of bad loans. Losses attributed to defaulted or delinquent loans have affected the banking industry to the point that nearly 10% of banks are considered to be financially unhealthy by the FDIC, the main regulator of the banking industry. Companies need profits to pay dividends and build shareholder equity. Lately, profits have been hard to generate for banks amidst their loan portfolio losses. Once known for stability in growth and dividends, bank stocks have become more volatile.

So with all the negative news about banks, should an investor disregard bank stocks completely? The answer is no. Despite an US economic recovery that is developing slowly, there are banks that have returned to financial health or are in the process of restoring themselves. In addition, many banks did not partake in the reckless lending like the banks that ended up receiving bailout dollars from the government in the Troubled Asset Relief Program (TARP). These bank stocks could in fact be undervalued on the market due to the contagion effect on all bank stock prices from the biggest banking disasters. Investors could find regional banks, community banks, online banks, and even some larger banks that are hidden gems. An investor just needs to know where to look.

Bank Stock News: Strong Returns for Bank Stocks in 2010

Bank stocks have had a relatively strong returns for the first eight months of 2010, after posting dismal returns in 2008 and 2009. The KBW Bank Index is up over 5% for the year, comparing favorably to major stock indexes including the Dow Jones Industrial Average (-0.27%), NASDAQ (-4.28%), and S&P 500 (-2.64%). Bank stocks have been helped by a slow return to profitability and from the watering down of the financial regulation bill passed recently in Congress. The current financial regulation bill includes a less restrictive version of what has been called the Volcker rule. The rule which is named after former Federal Reserve Chairman Paul Volcker, would have banned commercial banks from trading derivates simply to increase their profits. Pressure from the banking industry helped convince congressman to adopt a bill under which banks must trade derivatives on regulated exchanges, but are not barred from creating profits from positions on interest rates, commodities, and foreign exchange. Regional banks, with less exposure to European credit markets and without the stigma of taking TARP money, have fared better than their larger counterparts so far in 2010.

Bank Financials: Understanding the Basics

The biggest risk to a bank are bad loans or what is more formally called "credit risk". Mortgages, home equity loans, personal lines of credit, commercial loans, and credit cards are all forms of loans that banks make with the expectation that they will earn income as principal payments are made on time. The problem that exists is that anytime a consumer or corporation defaults on a loan, a loss occurs for the bank which must then be reflected on the bank's financial statement. This creates less profit or even a net loss for the bank. Bank stocks can also lose value when their assets, like real estate, depreciate with the market. Each bank has its unique level of credit and market risk that should be evaluated.

So how do banks actually earn money with all this inherent credit and asset risk? The primary goal of most banks is to manage the spread between deposits (liabilities, loans and assets) such that the income that a bank earns from loans and assets is greater than the interest it must pay on the deposits held for customers. This is called a positive net spread, but is easier to understand as the basic concept that a bank needs to charge a higher rate of interest on loans than they pay out on their bank CDs and other deposit products. An important percentage of a bank's profit is derived directly from this spread between the rate they pay for funds and the rate they receive from borrowers. Banks also derive income from fees they charge on their accounts which could include overdraft fees, service fees, closing fees, and processing fees. This income and the positive net interest rate spread, in general, has to greater than the operating expenses, capital costs, and bad loans that a bank writes off in order for a bank to be profitable. To make loans banks are sometimes borrowers themselves, borrowing from even larger sources of credit in order to lend out more money than they actually hold in cash reserves. Banks can face trouble if loan delinquencies accelerate and the banks have their own principal and interest payments to make.

Evaluating a bank's financial condition is important before deciding to invest in a bank's stock. Fortunately, banks are required to publicly disclose nearly all their financial information quarterly. This makes it easy for an investor to find online information for an individual bank regarding their loans, credit risk, interest rate spread, growth of deposits, and asset management. Is the bank growing too fast or too slow? Are delinquencies increasing? Is the bank creating a high overhead by opening too many branches? Are interest rates high enough to create profit opportunities for a bank? A careful evaluation of a bank's financial can help answer these questions. Comparing the financial statements of similar-type banks can also help investor find undervalued bank stocks. The FDIC and the Federal Reserve both list important data regarding banks on their websites.

Big Bank Stocks vs. Small Bank Stocks: Which Is Better?

An age-old question for investing in the stocks of banks is: Are large banks better than small banks? Every bank is different, but today bank investors are finding that many small regional banks have healthier balance sheets than the larger banks which became embroiled in the credit market debacle. The stocks of banks which were once large enough to be included in the Standard and Poor's 500 Index, have lost an average of over 50% of their pre-2008 value, compared to the 24% loss seen in an index of regional banks for the same time period. The day of assuming that large banks are better than small banks is probably over. As a general rule, any bank which grows their deposits or grows their number of branch offices too quickly can face growing pains. At the same time, a bank that doesn't grow their deposit base or loan portfolio is unlikely to increase profits consistently and pay competitive dividends to investors. The best answer for a bank investor is to evaluate each bank on their own merits and not give undue consideration as to whether big banks are better than small banks or vice versa.

Bank Stock Dividends: Rewarding Investors with Cash

One of the positive features of investing in bank stocks has always been that banks, on average, pay dividends at a higher rate than the rest of U.S. companies. In many cases, the dividend yield for a bank is even higher than the rates for that bank's certificates of deposit, money market accounts, savings accounts, or checking accounts. The problem is that no FDIC insurance exists for stocks, so an investor can lose money. Banks have always liked to pay consistent dividends because it builds up trust and confidence in their stock from the public. For instance, Raymond James Financial Inc. (RJF) announced early this year that their $0.44 per share dividend will remain in place, marking 25 consecutive years of paying dividends to their investors. This is the type of income consistency that some equity investors are seeking in their portfolio. At a current stock price of $27.19, an investor in Raymond James stock earns a dividend yield of 1.61%. Today, there a large number of banks paying dividends with yields between 0% and 3%. One caveat to remember is that the highest dividend yield is not always necessarily the best investing option. After all, the high dividend yield may be more reflective of an abrupt fall in the stock's price than anything else because the dividend yield of a bank stock increases when the stock prices decreases and vice versa. An example of this phenomenon is Flagstar Bank (FBC), whose stock price fell from over $140 in 2007 to below $3 in 2010. Today the dividend yield for Flagstar Bank stock is over 7%, more a reflection of the depressed stock price than solid earnings. Many of the nation's larger banks still have dividend yields below 1%. Listed below are the dividend yields of some of the top 100 largest banks in the country as ranked by deposit base.

Bank of America (BAC) dividend yield 0.25%

Comerica Inc (CMA) dividend yield 0.57%

Flagstar Bancorp (FBC) dividend yield 5.99%

Wells Fargo & Co (WF) dividend yield 0.72%

KeyCorp (KEY) dividend yield 0.45%

Regions Financial Corp (RF) dividend yield 0.56%

Check back with MoneyRates.com for the latest information on investing in bank stocks.

Last Updated: 8/23/10