Markets

Are Battered Banks Still Buys?

By Elizabeth Ody, Associate Editor

From Kiplinger's Personal Finance magazine, December 2008

Hardly had the ink dried on Beat the Rush to the Banks, in our November issue, when Lehman Brothers declared bankruptcy, setting in motion dramatic events that have altered the landscape of the U.S. banking sector. The most significant: Uncle Sam's move to inject $250 billion into U.S. banks and take equity stakes in nine of the largest.

Beyond that, consolidation is the new name of the game. After Washington Mutual's collapse marked the largest bank failure in U.S. history, JPMorgan Chase struck a $1.9-billion deal with the FDIC to acquire the thrift's banking operations and $307-billion loan portfolio. The acquisition vaults JPMorgan ahead of Bank of America as the largest U.S. bank by deposits.

Another transformational event, Bank of America's $50-billion acquisition of Merrill Lynch, will turn the consumer-banking powerhouse into the world's largest brokerage when the deal is completed in early 2009. And, after fighting off a competing offer from Citigroup, Wells Fargo won Wachovia with an $11-billion bid. The deal will give Wells Fargo the largest branch network in the country.

Meanwhile, the curtain has fallen on the golden age of investment banking. In September, Goldman Sachs and Morgan Stanley converted to conventional deposit-taking institutions. That gives them increased access to Federal Reserve funding, but at the expense of greater oversight. The banks will need to rein in the amount of leverage they use, precluding the possibility of returning to profitability highs anytime soon.

The market has chosen survivors, which means investors can get back to worrying about what the bank stocks are worth rather than which companies will still exist in a month. The big money-center banks still offer the most attractive opportunities. Standard & Poor's analyst Stuart Plesser says the elimination of competitors has undoubtedly been good for these businesses. And our November picks -- JPMorgan (symbol JPM), Wells Fargo (WFC) and Bank of America (BAC) -- proved themselves strong enough to be opportunistic in a crisis.

While Goldman and Morgan Stanley are unlikely to suffer the fate of Lehman or Merrill, their survivor status alone isn't reason to buy the stocks. Both appear to have more deleveraging to do -- a process of shrinking their businesses and possibly diluting shareholders with capital raises. Don't count on the stocks finding a floor until that process is complete.

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