Stop fighting the last banking crisis

Remember back in 2023 when Silicon Valley Bank, Signature Bank, and First Republic Bank all failed in rapid succession?

Mr. Market certainly does. And he seems to be punishing bank stocks today because of that past trauma.

Wall Street has an old saying that investors are always fighting the last war. And that struck me as true once again while reading a Wall Street Journal article earlier this week.

It was titled, “Bank stocks are haunted by the ghosts of 2023.”

I can’t say I get to read past every interesting headline I see. But I took the time for this one considering what’s happened since the Federal Reserve raised interest rates again.

Bond yields, as you probably know, have moved higher similarly to how they performed in 2023. And that’s caused investors’ minds to go back to that very recent lesson learned about duration risk.

At the time, certain banks had amassed enormous portfolios of low-yielding securities. So they were completely taken aback when interest rates – which had been at extreme lows – suddenly surged and those assets’ market value plunged.

Many financial institutions handled the volatility just fine. They had ample liquidity, sufficient capital, and large collections of much more stable deposits to fall back on.

However, there was enough regional drama that it left a mark on the stock market.

So yes, “the ghosts of 2023” haven’t disappeared. They’re still lurking around for the right lighting, which they seem to have found.

Yet as visible as they might be right now, they’re still ultimately memories. They have the power to scare us, yes, but little more than that.

Investors need to recognize that 2026 is not 2023. And banks are stronger than they used to be.

That Wall Street Journal article had an excellent example of market ghosts and their ability to scare.

Actually, it had several. This included how U.S. banks were sitting on nearly $330 billion of unrealized securities losses last quarter.

That’s not a small amount. In fact, it’s almost a third of a trillion dollars.

But it doesn’t tell the whole story.

The whole story is that, based on FDIC data, those unrealized losses represented only about 14% of banks' Tier 1 capital. Whereas they amounted to more than 33% back in Q3-22.

That's a major difference.

I’ve said many times before that real estate investment trusts (REITs) learned a valuable lesson from 2008. Having suffered so badly from the housing crash, they resolved to create stronger, more resilient balance sheets.

And so they did.

In the same way, banks have been working hard to both add capital and reduce the size of their securities portfolios. Likewise, they’ve allowed lower-yielding securities to mature while simultaneously shortening the duration of their bond holdings.

This matters because shorter-duration securities don’t tend to be as sensitive to interest rate changes.

As the Journal noted, more than 20% of banks’ securities had at least four years remaining until maturity in 2021. By Q2-26, however, that figure was down below 16%.

That’s why I’m confident financials will do much better if yields rise another 50 or even 100 basis points (bps) from here. And you should rest more easily in that knowledge as well.

I know that higher interest rates aren’t the easiest business environment to work within. But they don’t automatically destroy every business.

In fact, some businesses can even benefit from them under the right circumstances, including banks. If that sounds unlikely, just think about how the basic bank works.

It amasses funding in the form of deposits and other capital. Then it puts that money to work through loans and securities.

And when rates rise, floating-rate loans and those with shorter durations can reprice upward – sometimes quite quickly.

That begs another comparison between then and now, with further favorable results. The Journal also reported how loans that were maturing or otherwise repricing within three months represented less than 20% of U.S. bank assets in 2021.

But that figure was about 25% in Q2-26, meaning that banks can much better take advantage of higher rates. Analysts are even now expecting net interest margins to improve for bigger financial institutions.

Investors just haven’t accepted their evaluation, leaving banking stocks lower than they should be.

I'm not trying to say that 2023 will never happen again. Or that every bank will flourish now that rates are hiked.

There are still major risks to be aware of, with two I'm watching in particular.

One of them is deposit costs. After all, consumers and businesses alike are pretty rate-sensitive at this point. So banks shouldn’t assume that customers will leave billions of dollars lying in their accounts.

This is especially true when money-market funds, Treasury bills, and other cash alternatives are offering more attractive yields. And people are able to recognize that more and more thanks to artificial intelligence.

AI-powered financial tools are already making it easier for customers to compare rates. Moreover, while switching accounts can be exceptionally annoying – to the point where most people would rather not deal with the hassle even if their returns suffer for it – AI is moving toward the point where it can take on that kind of task as well.

Then there’s the second risk, which is credit quality. While banks can benefit from floating-rate commercial loans resetting from 5% to 7%, consumers obviously do not. So borrowers could increasingly default on their loans under these conditions.

That’s why I don’t want just any bank to back as this (muted) drama plays out. As always, I want a quality company.

A quality company like Bank of America (BAC).

Bank of America is far from the regional banks that fell apart in 2023.

It benefits from enormous scale along with a diversified deposit franchise. It has impressive consumer, commercial, and investment banking operations. And its wealth management business through Merrill is a solid moneymaker, too.

But more importantly, Bank of America has considerable financial strength to fall back on if times truly do get hard.

It’s still a financial institution. So there’s always the chance that it could suffer from the rising cost of funding, economic weakness in general, or credit losses specifically.

But I believe those risks are nominal.

Bank of America is currently trading at 12.3x price to earnings (P/E) compared with its historical ratio closer to 13.5x. So there’s a nice discount involved thanks to current market fears.

Investors who get in now would see an almost 10% multiple expansion if BAC simply returned to its normal multiple. And that’s before factoring in earnings growth. Or its dividend, which is yielding 2.4%.

Speaking of which, Bank of America has faithfully paid its investors out for 46 consecutive years now and increased it for the last 12. In 2014, annual dividends amounted to $0.12 per share; this year, it’s $1.20.

That’s a 10-fold increase, which works out to an amazing 21.2% compound annual dividend growth rate.

I’m not betting on that continuing quite so nicely from here, admittedly. A good bit of that growth came after Bank of America recovered from the global financial crisis.

It’s normalized more recently, but I’m still interested in the company thanks to its combination of:

Mr. Market can sit in a corner cowering all he wants. I just can’t bring myself to be afraid of the ghosts of 2023 though.

Not with what Bank of America is offering these days.

Happy SWAN Investing!

Brad Thomas,
Editor, Wide Moat Daily