By Jonnelle Marte
The murky outlook for the financial industry pushed safety-seeking investors toward small banks. But some analysts say their recent popularity has made them too pricey.
Wells Fargo and J.P. Morgan Chase beat expectations in their earnings reports Friday, kicking off what is expected to be a decent earnings season for U.S. banks. Big banks do face certain headwinds, however, including weak demand for loans and an uncertain regulatory environment. As a result, many investors have been flocking to the less-volatile stocks of smaller banks — often at a steep price, analysts say. Indeed, the KBW Regional Banks index had a forward price-to earnings ratio of 15 at the end of March, compared to 11 for the KBW Bank Index, which includes giants like Bank of America and J.P. Morgan Chase. “Unfortunately, if you’re looking for value you’ll have to take on a little more risk,” says Jim Sinegal, the lead banking analyst for Morningstar.
Bigger banks face challenges that smaller banks with more basic business models are spared, analysts say. Banks with more than $10 billion in assets must work within regulations limiting how they trade capital and charge fees, says Tim Holland, a portfolio manager at Tamro Capital Partners, an investment advisory firm based in Alexandria, Va. Smaller banks, on the other hand, “have a bit more freedom and have the potential to take clients that don’t like the fees some of the larger banks are putting in place,” he says.
Despite the risks, analysts say big banks have a few things working in their favor. Weak demand for loans makes it difficult for banks of all sizes to profit from their deposits, but larger banks make more money off of those deposits by paying lower rates, says Dan Geller, executive vice president at Market Rates Insight, a financial analysis company. Local and regional banks have to be more competitive with the interest rates they offer on savings and checking accounts because they don’t have the brand recognition of the big names, says Gellar.
Risk-averse investors tend to favor stocks from smaller and regional companies because of their more stable performance, says Sinegal. While bigger banks outshined small banks so far this year, they also suffered steeper losses in 2011. The KBW bank Index is up 22% year to date, after dropping 25% in 2011. The KBW Regional Banks index is up 11% but only fell 7% last year. Both outperformed the S&P 500 index, which is up 10% so far this year.