Big banks and safety aren't always terms that go together. I've made the case several times that BB&T Corporation (NYSE:BBT) could be the best investment in the banking industry. BB&T has consistently delivered strong organic deposit and loan growth, along with good credit quality. However, there is one bank that based on recent results looks poised to take BB&T's crown. U.S. Bancorp (NYSE:USB) has the potential to take over as my favorite bank investment, and the race is already very close.
This Isn't That Complicated Banking is made out to be this extremely complicated business by the media. When people hear about derivatives, hedging, and complicated trades, they assume that all banks are hard to understand. In truth, banking is a simple business of attracting deposits and making loans. Of course, one of the important aspects of making loans is managing credit quality. With the challenges of the Great Recession still lingering, credit quality is under even more intense scrutiny. Banks that can grow their deposits and loans organically should be sought after. If you find a bank that has good credit quality and quality growth, it should go to the top of your buy list.
The way most banks account for loan issues is, by setting aside money through loan loss reserves. Allocating this loan loss provision punishes their earnings in the short term. However, if the bank is able to avoid charging off these loans, they are able to release some of this reserve, which improves earnings. The reason this is important to understand is, banks with a high percentage of loan loss reserves, may offer the opportunity for positive earnings surprises in the future.
It's All About Quality Banks with good quality loans have less expenses tied to solving problem loans. Lenders can focus on generating new loan growth versus trying to collect on existing balances. If you want proof of this relationship, look at the difference in loan growth relative to non-performing loans at several of the top banks.
|Name||Loan Growth||Non-Performing Loan Percentage|
|J.P. Morgan Chase (NYSE:JPM)||(5%)||3.12%|
|U.S. Bancorp (NYSE:USB)||8.60%||1.10%|
|Wells Fargo (NYSE:WFC)||2.42%||2.56%|
I notice a pretty clear relationship. Banks with a better non-performing loan percentage seem to also have better loan growth. Though J.P. Morgan and Wells Fargo are commonly mentioned as strong banks, they can't match either BB&T or U.S. Bancorp in organic loan growth.
Loans and deposits are the two most important ways to measure organic growth at a financial institution. A bank can't have just good loan growth, or their lack of deposits will cause them to borrow funds to meet their lending needs. On the other hand, a bank can't have just deposit growth, or their lack of loans will compress their interest margin. We just saw that both U.S. Bancorp and BB&T have good loan growth, but what about their deposit growth?
In the current quarter, U.S. Bancorp showed average deposit growth of 9.2%, which was second only to J.P. Morgan's growth of 10%. BB&T and Wells Fargo had good deposit growth, but at 8.1% and 7.39% respectively, they couldn't match their two faster growing competitors. That being said, keep in mind only U.S. Bancorp and BB&T showed solid growth in both categories.