Bank stocks are tumbling following the failures of SVB Bank SIVB, and Signature Bank SBNY, -22.87% ), but there are good reasons to invest in these contrarians. First, federal regulators have made it clear they will support banks on the brink. Trouble due to flight of depositors. The Federal Reserve will credit banks against the full value of losing positions in Treasuries. “It will help banks meet deposit requests,” says Ian Leppe, portfolio manager at Gabelli Global Financial Services Fund GAFSX, +1.04% . Second, regulators have indicated they will return bank deposits above the $250,000 cutoff for Federal Deposit Insurance Corporation (FDIC) insurance. “That should generally ease the panic of depositors because the government says you’re not going to lose money,” Leppe says. “There is no reason for a depositor to withdraw money from any bank now, unless they think they can get a better rate.” If more trouble arises, regulators won’t stop there. “The FDIC, the Treasury and the Federal Reserve will ultimately do what they have to do to bring peace to the banking system,” Spencer Lerner, strategist at Harbor Capital Advisors, said on a client call Monday. Third, yields on Treasuries have fallen significantly. This increases the value of debt securities held by banks and improves their financial strength, says Leppe. Read: Government bonds held by banks could be the so-called ‘toxic asset’ of the next financial crisis, fund managers say If you’re considering investing in the banking sector now, consider these strategies: 1. Go big: The most conservative way to gain exposure to the banking sector is through stocks of large money-center banks. Potential gains are small, but these stocks haven’t fallen as much as regional banks and are unlikely to fall. Even the biggest banks can be winners in a crisis. If depositors flee regional banks, the big banks will take a portion of the deposits because they are perceived as safe, Lepay says. This makes sense because larger banks have more diversified businesses. JPMorgan Chase JPM, -5.40% , for example, derives a significant portion of its earnings from non-deposit businesses such as investment banking, money management and trading. “JP Morgan will be absolutely fine,” says Nancy Tengler, chief investment officer at Leffer Tengler Investments. Read: Bank of America is raining money. The SVB fallout from Citigroup C, -5.86% reportedly saw an inflow of more than $15 billion among Lapay singles. “I don’t see them risking a run on the bank,” he says. To calculate tangible book value, Lepay takes a more conservative approach than many sector analysts. It discounts the value of Treasuries and other debt instruments that banks carry at full value because they say they will hold them to maturity. Lappy’s more conservative approach to valuation shows that Citigroup has a tangible book value of $70 per share. Larger banks like Citigroup start to look attractive on tangible book ratios in the lower range and the ratio for this bank is .67. Leppe says Citigroup is well capitalized and pays a 4.3% dividend yield. 2. Go with big regional banks: Small regional banks face the risk of depositor flight and rising funding costs and will need to raise rates to keep deposits, warns Dave Ellison, portfolio manager at Hennessy Large Cap Financial Investor HLFNX, -1.38% . But he is not too worried about the big regional banks. So-called superregionals, including Fifth Third Bancorp FITB, -5.71% Trust Financial TFC, +1.16% , Regions Financial RF, -6.14% , US Bancorp USB, -4.81% and M&T Bank MTB, -2.69% should be relatively unscathed, Allison says. . “These are the ones that can hang in there and get through, and possibly take some of the distressed and failed banks,” he adds. “I don’t think you sell high-quality banks. I don’t sell them.” One reason is that these banks primarily do basic, traditional local community banking, offering working capital loans, home mortgage loans and credit card loans to companies. “They don’t make very large commercial real estate loans or loans to risky startups,” Ellison says. “Their traditional banking model is tried and true over the credit cycle.” Also, their core deposit base is safer because it is more “granular”. This means they have many small deposit accounts with insured balances below $250,000. These customers are less likely to transfer their accounts. For comparison, about 90% of deposits at SVB Bank were uninsured. In these large regional banks it is in the range of 30% to 40%. All these banks offer a nice dividend yield in the 4% to 6% range. 3. Go Small: Smaller banks tend to have stronger business relationships with their customers, says Tim Melvin of Bank Takeover Letter, which has tracked buyer executives at banks to try to identify takeover targets. They also lack exposure to venture capital-backed startups and crypto companies, which has left SVB Financial and Signature Bank in trouble. One bank Melvin likes is LCNB LCNB, -2.73% , a $185 million market cap bank based in Lebanon, Ohio. “This is a good, small-town bank. There is no reason for it to be stocked down,” says Melvin. “They have a great history of not making stupid loans and growing their dividends.” The stock is cheap, trading at just 1.3 times tangible book value. Melvin Home Bancshares HOMB, -2.93% also singles out as another conservatively run, smaller bank. It is growing through acquisitions, so the weakness of the current bank sector may help it find targets. Leppe, at Gabelli, highlights Glenville, NY-based Trustco Bank TRST, +0.92% , one of their largest positions. The bank is conservatively managed, he points out, so it has virtually no capital base in debt instruments. It also has no exposure to crypto companies and venture capital-backed startups. “The two banks that failed were largely exposed to areas that are bubbles in the process of bursting,” Leppe says. 4. Wait for the dust to settle: Not everyone is convinced that now is the time to buy the banking sector. Larry MacDonald of the Bear Traps Report says banks face the risk of a recession if they need to sell shares and turn to the stock market to raise funds. He adds that Washington’s defense plan is not just that. He thinks banks will be reluctant to go to the Fed discount window to borrow against Treasuries because investors will see that as a sign of trouble. To avoid this issue in the Great Financial Crisis, regulators forced all major banks to take support, whether they needed it or not. Another emerging issue, says Alison at Hennessy, is banks pulling back on lending to maintain their balance sheet strength. This will reduce revenue growth. Meanwhile, they will have to pay more on deposits and this will affect profit margins, adds Ania Aldrich, portfolio manager at Cambiar Investors. “There will be more negative than positive news for the banks,” she says. “Earnings will continue to correct lower.” Also, a loan contraction could accelerate any economic downturn that was already on the way. “Banks are tightening lending standards, and smaller companies are hurt the most,” says Lerner at Harbor Capital Advisors. It is important because small companies are the backbone of the economy. “It’s dragging out the timing of the recession that we expected.” If there is a recession, it will make matters worse for banks. Finally, there is the risk of another bank shutdown driven by another bank. Alison says: “You never know.” Michael Brush is a columnist for MarketWatch. At the time of publication, he had no position in any of the stocks mentioned in this column. Brush suggested JPM, C, and FITB in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks More: Are your deposits safe? Where Should You Put Your Cash Amid Banking Fears? Financial advisors provide tough love. Also read: SVB’s collapse exposes the Fed’s colossal failure to see the bank’s warning signs
