5 Cheap Bank Stocks to Buy Now

What they are: The sector covers a broad range of institutions, from megabanks, such as Citicorp (symbol C) and Bank of America (BAC); regional banks, such as Huntington Bancshares (HBAN) and PacWest Bancorp, in California (PACW); and small, obscure outfits, such as Hanmi Financial (HAFC), a California-based firm that targets the Korean-American community, and Southside Bancshares (SBSI), headquartered in Tyler, Texas.

How much they’ve fallen: Even after jumping 8.3% over just two trading sessions (on February 12 and February 16), stocks in the KBW Bank index have sunk 18% so far this year. That compares with a decline of 9% in Standard & Poor’s 500-stock index. Since late July, the KBW Bank index has plunged 23%, and the KBW Regional Bank index, which tends to be steadier than the megabank bogey, has fallen 17%. Over the same period, the S&P 500 declined by 10%. (All returns and share prices are through February 16.)

Why have banks performed so poorly? Some investors worry that a global economic slowdown, led by China and other developing nations, could slam big banks, many of which have a global reach. Another concern is that many struggling energy producers could default on their debt obligations, hurting banks that have loaned them money.

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Moreover, the U.S. economy hasn’t exactly been firing on all cylinders. The strong dollar has knocked U.S. manufacturing firms into “recession-like” territory, says Joe Davis, Vanguard’s chief economist, and that’s one reason Davis expects interest rates to stay low for a long time. The prospect of low rates is an even bigger concern for investors in bank stocks. Although the Federal Reserve raised short-term interest rates in December—the first hike since 2006—and has indicated that it might raise rates four times this year, most pundits think that weak global economic growth and turmoil in financial markets are likely to stay the Fed’s hand. Many observers, including Kiplinger, expect no more than two increases this year.

Making matters even worse, rates on long-term, high-quality bonds, which are set by investors in the bond market, have been falling. For instance, the yield on the benchmark 10-year Treasury bond has plunged from 2.38% in November to 1.77%, a huge move by the normally sedate standards of the bond market. That has resulted in a flattening of the yield curve—the relationship between long-term and short-term Treasury bond yields—which makes it “difficult for banks to be profitable,” says Omar Aguilar, chief stock strategist at Charles Schwab Investment Management. A flattening yield curve pinches profits because it reduces the difference between the rate at which banks can borrow and the rate at which they lend (banks tend to fund most long-term loans through short-term deposits).

Why the bears may be wrong: Many U.S. banks have minimal exposure to China and other emerging nations, says Aguilar. Moreover, banks have much stronger balance sheets and are far less leveraged today than they were during the 2007-09 Great Recession and financial crisis. That could help them withstand a credit crisis in energy bonds, should one materialize.

And the U.S. economy is on a more solid footing than most of the rest of the world. Katie Nixon, chief investment officer of wealth management at Northern Trust, points to record auto sales and a robust housing market as positive signs. And with consumer spending accounting for 70% of America’s gross domestic product, “we’re in good shape,” she says.

Schwab’s Aguilar agrees: “If the U.S. economy continues the way it is, the Fed will raise rates, and that would be positive” for bank stocks. He predicts that investors will turn much more positive on the group before the end of 2016. Meanwhile, he adds, the stocks have been so hammered that they are “trading at recession levels.”

Some bank executives (current and former) seem to agree. Jamie Dimon, CEO of JPMorgan Chase (JPM), picked up 500,000 shares of his company’s stock on February 11, fueling an 8% jump in Morgan’s shares the following day. Around the same time, Richard Kovacevich, the former CEO of Wells Fargo (WFC), bought Wells shares. Both executives, it’s worth mentioning, were big buyers of their respective stocks in 2009, as prices slumped in the throes of the financial crisis.

What to buy: Focus on the big banks. “We’re bullish” on the so-called money-center banks, says Patrick Kaser, managing director at money manager Brandywine Global. He says shares of both Citigroup, at $38.89, and Bank of America, at $12.25, trade for less than their tangible book value (what their assets, less liabilities, would fetch if they were to be liquidated). Banks haven’t traded that cheaply, as a group, since 2012. Northern Trust’s Nixon says that in good times bank stocks have traded at twice their tangible book value.

John Toohey, head of stocks at USAA Investments, sees opportunity, too. “Things may not be as bad as financial stock prices are reflecting,” he says. His top picks include Bank of America, BB&T (BBT, $32.58), KeyCorp (KEY, $10.91) and PNC Financial Services Group (PNC, $83.27).

To bet on the big banks, consider PowerShares KBW Bank ETF (KBWB). The exchange-traded fund holds 26 stocks, ranging in size from Wells Fargo ($48.24), with a market capitalization of $246 billion, to Zions Bancorp (ZION, $21.68), with a market cap of $4.4 billion.

Sprinkle some regional banks into your portfolio because their stocks also look cheap. They’ve been walloped mostly over worries that some firms might have exposure to energy-company debt. In line with that, iShares US Regional Banks ETF (IAT) and SPDR S&P Regional Banking ETF (KRE) have slipped 19.1% and 20.2%, respectively, since late July. The SPDR ETF has 85% of its assets invested in small and midsize banks. The iShares fund has less than 60% of its assets in small and mid caps. SPDR S&P Bank ETF (KBE) holds both money-center and regional banks, with roughly equal weightings for each stock in its portfolio. Its top holding: New York Community Bancorp (NYCB), based in Westbury, N.Y., and with operations in New York and four other states.