The Federal Deposit Insurance Corporation (FDIC) made its first bailout in 1980 to First Pennsylvania Bank, the 23rd largest bank in the country, after concluding that its failure would have serious and widespread financial repercussions.
With the obvious and much more recent bailouts, why would I lead with the much smaller First Penn example? To show that bailouts of big financials are nothing new. Even before the FDIC, the Federal Reserve was created in 1913 to act as a, “lender of last resort,” by providing funds to solvent banks during liquidity crises.
What does this mean for your portfolio? It means you get bank earnings and a strong dividend yield backed by the full faith and credit of the United States. You could buy a 10-year Treasury Note and get 2.6%, or you can buy bank shares and get a 2%+ yield with capital gains.
Remember TARP?
The $700 billion Troubled Asset Relief Program (TARP) was supposed to go to buying distressed assets and mortgage-backed securities, but 89% ended up going to 32 big banks. These mega-banks, along with a handful of smaller institutions, were judged to be too important to the financial system. While no definitive demarcation was given for too-big-to-fail, the institutions generally had in excess of $50 billion market capitalization.
US Bancorp (USB) is just about the smallest of the mega-banks at a market cap of $70 billion. It’s also one of Warren Buffett’s largest holdings with Berkshire Hathaway (BRKB) holding almost $3.0 billion in shares or 4% of the company. The bank is extremely well-managed and even at the peak of the financial crisis only saw charge-offs a little over 2%. The shares pay a 2.4% yield and trade at 12.8 times trailing earnings.
JP Morgan (JPM), one of the largest banks at $204 billion, is said to have reached a record $13 billion deal to settle the government’s investigation into mortgage bond sales leading up to the housing bubble. Despite the record penalty and the firm’s need to take a $7.2 billion charge in the third quarter, the stock has done well lately and the payout is less than the $21 billion the bank made last year. Most of the bonds in question were sold by Washington Mutual and Bear Stearns, which JP Morgan was asked to acquire during the crisis. The shares pay a 2.8% dividend yield and trade at 12.2 times earnings.
Wells Fargo (WFC) is another favorite of Warren Buffett, in fact it is his largest position in the Berkshire portfolio with $19.3 billion in shares, controlling almost 9% of the bank. The $224 billion bank is the largest U.S. lender, accounting for nearly a third of all home loans. The rise in rates may be taking its toll on the lender and it cut approximately 5,300 full-time employees in the third quarter. The shares pay a 2.8% dividend yield and trade relatively cheaply at 11.2 times earnings.
Of course, you could always go with the Financial Select Sector SPDR (XLF) which gives you exposure to all the big banks but it only yields 1.6% and you have to take the bad with the good.
JP Morgan is much more focused on institutional trading and capital markets, which makes the combination with either Wells Fargo or US Bancorp a good diversifying play. The capital market-focused banks have seen lower fixed-income trading recently with higher rates but equity trading and M&A activity is stronger. The retail-focused banks are seeing mortgage and refinancing activity slow but the consumer remains strong.
I do not think it is a good strategy to invest into big banks as a source of dividends because they will be backed up by the US government. The banks you are naming were among those in a lot better shape. But many went under. Although they were bailed out, they stopped paying dividends and that is not a thing you want to have in your portfolio. As an example BAC, C, and others.