It's been a decade since the collapse of Lehman Brothers, and mortgage crisis and the subsequent Great Recession are things of the past for investors, bankers and regulators now. In fact, a few years of low default rates and solid loan growth have helped bankers gain confidence. Banks now have more capital cushion, are into stable funding, are exposed to less risky businesses and are well guarded by stringent regulations.
The current economy, by the by, is picking up at a solid pace. This in turn justifies steady interest rate hikes. Thus, investing in bank stocks that have made the most since the 2008 Lehman crisis seems prudent.
Lehman Collapse Explained
A decade back, Lehman Brothers was leveraged at 30.7 to 1. In fact, hedge fund manager David Einhorn thought that Lehman Brothers, if calculated properly, had a leverage of 44 to 1. While leverage does improve returns when the time is good, it causes serious problems when it is not.
Einhorn explained that even a 1% fall in the value of investments made by Lehman would erode half its equity and push the leverage to 80 times. To understand it better, let's say the firm has $1, borrows $44 and invests $45 in total. Now, if the investment declines 1%, the resultant loss is 45 cents. This in turn needs to be adjusted with the firm's equity of $1. Thus, the firm has only 55 cents left of its money. It should also not be forgotten that the company has borrowed $44. Now, the firm's leverage is 80 ($44/55 cents).
Lehman, thus, was at a high risk zone. After all, this leverage came back to haunt it in the form of subprime mortgage crisis. It had to file for bankruptcy in the Southern District Court of New York on Sep 15, 2008.
How Banks Are Placed on the Eve of 10th Anniversary of Lehman's Crisis
Banks are much safer now. There has been a sharp rise in capital requirements, which acts as a buffer against losses. Lehman and other major firms in 2007 had about $2 for every $100 of assets. That meant the value of the assets just needed to fall 2% for the equity to be completely wiped out. Now, it's around $7 for every $100. Thus, banks have bigger buffer to counter unforeseen losses if the market crashes. The aggregate Common Tier 1 - the core measure of a bank's financial strength - has gone up 72% since the Lehman crisis.
Daniel Tarullo, who oversaw financial regulation at the Federal Reserve until last year, said that "it would be good for banks to have a bit more capital and be even more resilient, but what we've got right now, if preserved, is pretty good."
Funding has also gained more stability. Banks have considerably reduced their dependency on short-term funding and are relying more on deposits, because they are backed by insurance. The Goldman Sachs Group, Inc. GS , in particular, hardly had any deposits before the crisis. But, now 16% of the investment giant's financing depends on deposits. Goldman is also trying to expand its retail-banking franchise.
At the same time, banks have partially turned away from risky trading activities and are focusing more on plain-vanilla banking activities, including lending to companies and consumers. Regulations such as the Volcker Rule, a key provision of the 2010 Dodd-Frank Act led to this shift by discouraging risky trades.
Dodd-Frank intended to better regulate financial institutions and safeguard their customers, by the way, did constrain banks' returns. Thus, the Trump administration did roll back some of the stringent Dodd Frank rules. It exempted smaller banks (under $10 billion in assets) from complying with the Volcker Rule, which restricts financial firms from making risky investments. It has also eased some of the home loan rules applied on small banks. Such banks, thus, should see considerable growth in the near term.
Powell Backs More Rate Hikes
With the Fed hiking rates and aiming for more increases this year, banks stand to gain. Federal Reserve Board Chairman Jerome Powell told the Senate Banking Committee that "with a strong job market, inflation close to our objective, and the risks to the economy roughly balanced, the FOMC believes that - for now - the best way forward is to keep gradually raising the federal funds rate."
The Fed has already raised its benchmark federal funds rate by a quarter percentage point to a range of 1.75% to 2% this year. The Fed's dot plot, in fact, indicated that policy makers predict two additional rate hikes this year for a total of four increases instead of the three planned earlier.
Higher interest rates can boost bank profits as they increase the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities.
5 Top Gainers
Given the aforesaid positives, banks have come a long way since the worst financial crisis in almost a century. This is also evident from the fact that Goldman Sachs, Wells Fargo & Company WFC and JPMorgan Chase & Co. JPM employees earned nearly $12.5 billion from stock options since the 2008 crisis.
We have, thus, selected five bank stocks that have gained the most in the last 10-year period. These stocks also boast a Zacks Rank #1 (Strong Buy) or 2 (Buy).
SVB Financial GroupSIVB provides various banking and financial products and services. The company has a Zacks Rank #1. In the last 60 days, 12 earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 8.1% in the same period.
The company's projected growth rate for the current year is 74.5%, while the Banks - West industry is expected to rally 28%. The company has outperformed the broader industry in the last 10 years (+377% vs +90.3%).
Commerce Bancshares, Inc.CBSH operates as the holding company for Commerce Bank that provides retail, mortgage banking, corporate, investment, trust, and asset management products and services to individuals and businesses. The company has a Zacks Rank #2. In the last 60 days, three earnings estimates moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 1.8% in the same period.
The company's projected growth rate for the current year is 40.1%, while the Banks - Midwest industry is expected to rally 29.4%. The company has outperformed the broader industry in the past 10-year period (+119.1% vs +47.7%).
Blue Hills Bancorp, Inc.BHBK operates as the bank holding company for Blue Hills Bank that provides financial services to individuals, families, small to mid-size businesses, government, and non-profit organizations in Massachusetts. The company has a Zacks Rank #1. In the last 60 days, one earnings estimate moved north, while none moved south for the current year. The Zacks Consensus Estimate for earnings rose 8.7% in the same period.
The company's projected growth rate for the current year is 78.6%, while the Banks - Northeast industry is likely to rally 22%. The company has outperformed the broader industry in the past 10 years (+87.9% vs +73.4%). You can see the complete list of today's Zacks #1 Rank stocks here.
National Bank Holdings CorporationNBHC operates as the bank holding company for NBH Bank that provides various banking products and financial services to commercial, business, and consumer clients in the United States. The company has a Zacks Rank #2. In the last 60 days, three earnings estimates rose, with no movement in the opposite direction for the current year. The Zacks Consensus Estimate for earnings rose 5.9% in the same period.
The company's projected growth rate for the current year is 69.8%, while the Banks - Southeast industry is expected to rally 31%. The company has outperformed the broader industry in the last 10-year period (+95.8% vs +46.3%).
First Financial Bankshares, Inc.FFIN provides commercial banking products and services, primarily in Texas. The company has a Zacks Rank #2. In the last 60 days, three earnings estimates moved up, while none moved down for the current year. The Zacks Consensus Estimate for earnings rose 2.8% in the same period.
The company's projected growth rate for the current year is 28.8%, while the Banks - Southwest industry is estimated to rally 14.6%. The company has outperformed the broader industry in the last 10-year period (+218.4% vs +70.2%).
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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free reportJPMorgan Chase & Co. (JPM): Free Stock Analysis ReportWells Fargo & Company (WFC): Free Stock Analysis ReportCommerce Bancshares, Inc. (CBSH): Free Stock Analysis ReportBlue Hills Bancorp, Inc. (BHBK): Free Stock Analysis ReportNational Bank Holdings Corporation (NBHC): Free Stock Analysis ReportFirst Financial Bankshares, Inc. (FFIN): Free Stock Analysis ReportSVB Financial Group (SIVB): Free Stock Analysis ReportThe Goldman Sachs Group, Inc. (GS): Free Stock Analysis ReportTo read this article on Zacks.com click here.Zacks Investment Research