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The Brexit, the U.K. referendum to leave the European Union that passed last week, has sent the markets into turmoil, notably the financial markets. The Financial Select Sector SPDR Fund (NYSE: XLF) has fallen over 5% since the Brexit vote.
Investors are rushing to sell financials; the Brexit is one more element in the perfect storm encompassing the U.S. banks. First, banks face the seemingly perpetual low-interest-rate environment. Banks make money on the interest they charge borrowers, so low rates means less income. A Brexit only further lowers the likelihood of a rate hike in the near term.
Now, the Brexit will put a damper on the U.K. economy and could even send other parts of Europe into a recession. That would have some impact on U.S. banks doing business overseas. Yet, the U.S. banks are in much better shape than they were just five years ago.
Billions Lost in Market Value
In overreaction to Brexit vote, banks have lost tens of billions of dollars in market value over the last week. But are U.S. banks simply getting thrown out with the bathwater? Should big U.S. banks like Bank of America (NYSE: BAC) be down as much as U.K.-based HSBC Holdings (NYSE: HSBC)? That’s a big question, especially when U.K. banks will be hit much harder by the isolation of the U.K.
U.S. banks recently passed the Federal Reserve’s annual stress tests, suggesting their balance sheets are more than strong enough to handle the Brexit fallout and potential U.S. economic slowdown. These tests look at how strong bank earnings and balance sheets would be in extreme situations, which is apropos timing with the Brexit.
The U.S. banks certainly have a few headwinds working against them, but at a certain price everything is a buy. The big banks are now just as cheap as they’ve been in three years. For the prudent long-term investor, this could be a great buying opportunity.
Here are the top three bank stocks to buy on the Brexit overreaction:
Bank Stocks to Buy Now, No. 1: Bank of America
Bank of America (NYSE: BAC) has put the majority of its mortgage-related problems behind it. Bad loans are gone and profitability is steadily rising. But Bank of America stock has fallen over 14% in just the last month. Shares are now down 24% in 2016.
The stock is now trading at 55% of book value, at three-year lows. Meanwhile, its return on equity is at five-year highs. There are still plenty of opportunities for Bank of America to boost profitability. It can reducing non-interest expenses, which at over 70% of revenues is high compared to peers. Then there’s also the potential for a catalyst event to help unlock value at Bank of America, namely a spinoff of Merrill Lynch.
Bank Stocks To Buy Now, No. 2: Goldman Sachs
The big investment banks have also been catching it on the chin given Brexit. Goldman Sachs (NYSE: GS) is the biggest that is feeling the pain. Goldman shares are down 12% in the last month. Goldman makes more money from the capital markets than many peers, which will be a positive if the U.S. and other parts of the world can shake off the Brexit news.
The Brexit also provides Goldman with a silver lining. Goldman should be able to capture market share from peers. The Brexit will provide even more impetus for many U.S. and European investment banks to continue restructuring away from capital markets and typical investment banking activities, leaving the door open for Goldman.
Bank Stocks To Buy Now, No. 3: Citigroup
Citigroup’s (NYSE: C) stock is now down close to 22% on the year, and trading at just 57% of book value. And just like Bank of America, its return on equity has improved drastically over the years; ROI is now at eight-year highs.
The beauty of Citi is that unlike other U.S. banks, it’s more levered to growth overseas, namely in the Latin America and Asia markets. So, even if U.S. loan growth starts to slow, Citi will have a growth avenue.
In the end, it might be early to go piling into financials, but it’s certainly a good time to add a few big banks to your watch list. The three above have been some of the hardest-hit in the U.S. this year, but could soon be entering deep value territory.
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