Bill Gross: U.S. Banks Need to Be Recapitalized

Bill Gross, managing director of the world's largest bond fund, said Tuesday, "U.S. banks have not done enough to ensure they are well capitalized, and getting back to a system where retail and investment banking are separated would be attractive in terms of reform."

"The closer we get back to separating the two, I suppose the better from the standpoint of reform," says Gross, whose firm Pacific Investment Management Co. (PIMCO) runs a $242.2 billion total returns portfolio.

His comments are also in connection to MF Global, formally known as Man Financial, which is not a bank, but a futures broker run by former Goldman Sachs chief Jon Corzine. MF Global filed for Chapter 11 bankruptcy on Monday after a tentative deal with a buyer fell apart, reports CNBC. "A top U.S. exchange regulator said the firm failed to protect customer accounts by keeping them separate from its own funds, leading to another shock for commodity markets scrambling to contain the fallout from the brokerage's bankruptcy."

Gross weighs in his opinion: "Wall Street sort of lost its way, in that investment banking became a function not of allocating capital properly, but levering capital and levering the returns on capital as opposed to transferring capital to productive industries."

Echoing his sentiment, Liz Ann Sonders, chief investment strategist at Schwab, said on the topic of the MF Global situation: "It's another hit to the confidence certainly of individual investors who have, maybe rightly so, felt that the whole game is rigged against them." (via CNBC)

He adds that he believes there is a 50-50 chance of whether or not Greece will be dropped from the Euro. Perhaps, he thinks, it would be for the best. The move would be similar to what happened in Iceland, a country that he believes recapitalized properly. "They basically told the banks to stuff it, to basically take their money and go home. Perhaps Greece should do that, or otherwise they're in for a five-, 10-, 15-year period of time of very difficult circumstances."

Contrarian ideas
Bill Gross might be bearish on the financial industry, but we've found several examples where highly profitable banks are trading at attractive valuations.

Now might not be the right time to buy, but there are many quality names to keep on your watch list.

All the banks mentioned below have a track record of being more profitable than their competitors. In addition, all of these banks appear to be deeply undervalued relative to the Graham equation. (If you're looking for a complete explanation of the equation's construction, click here.)

Given the track records of these banks, do you think they will continue to be profitable? Or do you agree with Bill Gross, who has expressed extreme bearishness on the sector's outlook?

Use this list as a starting point for your own analysis. (Click here to access free, interactive tools to analyze these ideas.)

List compiled by Eben Esterhuizen, CFA:

1. Community Bank System (NYS: CBU) : Operates as the holding company for Community Bank. TTM gross margin at 80.86% vs. industry average at 72.36%. TTM operating margin at 42.65% vs. industry average at 39.66%. TTM pre-tax margin at 27.7% vs. industry average at 23.56%. Diluted TTM earnings per share at 1.95, and a MRQ book value per share value at 19.83, implies a Graham Number fair value = sqrt(22.5*1.95*19.83) = $29.50. Based on the stock's price at $24.66, this implies a potential upside of 19.61% from current levels.

2. Independent Bank (NAS: INDB) : Operates as the bank holding company for Rockland Trust Company that provides commercial and retail banking, and wealth management services in Massachusetts. TTM gross margin at 83.21% vs. industry average at 72.36%. TTM operating margin at 66.74% vs. industry average at 39.66%. TTM pre-tax margin at 25.02% vs. industry average at 23.56%. Diluted TTM earnings per share at 2.15, and a MRQ book value per share value at 21.48, implies a Graham Number fair value = sqrt(22.5*2.15*21.48) = $32.23. Based on the stock's price at $24.28, this implies a potential upside of 32.76% from current levels.

3. NBT Bancorp (NAS: NBTB) : Provides commercial banking and financial services to individuals, corporations, and municipalities in central and upstate New York, northeastern Pennsylvania, and the greater Burlington, Vermont area. TTM gross margin at 80.29% vs. industry average at 72.36%. TTM operating margin at 40.73% vs. industry average at 39.66%. TTM pre-tax margin at 24.73% vs. industry average at 23.56%. Diluted TTM earnings per share at 1.7, and a MRQ book value per share value at 16.29, implies a Graham Number fair value = sqrt(22.5*1.7*16.29) = $24.96. Based on the stock's price at $20.53, this implies a potential upside of 21.59% from current levels.

4. Tompkins Financial (NYS: TMP) : Tompkins Financial Corporation, through its banking subsidiaries, Tompkins Trust Company, The Bank of Castile, and The Mahopac National Bank, provides banking and financial services to individuals, corporations, and other business clients in New York. TTM gross margin at 80.61% vs. industry average at 72.32%. TTM operating margin at 40.99% vs. industry average at 39.6%. TTM pre-tax margin at 27.53% vs. industry average at 23.62%. Diluted TTM earnings per share at 3.15, and a MRQ book value per share value at 27.15, implies a Graham Number fair value = sqrt(22.5*3.15*27.15) = $43.87. Based on the stock's price at $37.75, this implies a potential upside of 16.2% from current levels.

5. East West Bancorp (NAS: EWBC) : Operates as the holding company for East West Bank, which provides a range of personal and commercial banking services to small and medium-sized businesses, business executives, professionals, and other individuals in California. TTM gross margin at 73.79% vs. industry average at 72.36%. TTM operating margin at 51.17% vs. industry average at 39.66%. TTM pre-tax margin at 33.28% vs. industry average at 23.56%. Diluted TTM earnings per share at 1.39, and a MRQ book value per share value at 15.37, implies a Graham Number fair value = sqrt(22.5*1.39*15.37) = $21.92. Based on the stock's price at $18.54, this implies a potential upside of 18.26% from current levels.

6. SVB Financial Group (NAS: SIVB) : Operates as the bank and financial holding company that provides commercial banking and financial products and services. TTM gross margin at 93.58% vs. industry average at 72.32%. TTM operating margin at 54.03% vs. industry average at 39.6%. TTM pre-tax margin at 41.06% vs. industry average at 23.62%. Diluted TTM earnings per share at 3.54, and a MRQ book value per share value at 35.5, implies a Graham Number fair value = sqrt(22.5*3.54*35.5) = $53.17. Based on the stock's price at $44.36, this implies a potential upside of 19.87% from current levels.

7. Community Trust Bancorp (NAS: CTBI) : Operates as the holding company for Community Trust Bank, TTM gross margin at 78.68% vs. industry average at 72.36%. TTM operating margin at 46.84% vs. industry average at 39.66%. TTM pre-tax margin at 26.95% vs. industry average at 23.56%. Diluted TTM earnings per share at 2.49, and a MRQ book value per share value at 23.58, implies a Graham Number fair value = sqrt(22.5*2.49*23.58) = $36.35. Based on the stock's price at $27.04, this implies a potential upside of 34.42% from current levels.

8. F.N.B. (NYS: FNB) : Provides various financial services to consumers and small to medium-sized businesses. TTM gross margin at 77.37% vs. industry average at 72.36%. TTM operating margin at 42.03% vs. industry average at 39.66%. TTM pre-tax margin at 23.7% vs. industry average at 23.56%. Diluted TTM earnings per share at 0.71, and a MRQ book value per share value at 9.6, implies a Graham Number fair value = sqrt(22.5*0.71*9.6) = $12.38. Based on the stock's price at $9.62, this implies a potential upside of 28.73% from current levels.

9. Trustmark (NAS: TRMK) : Operates as the bank holding company for Trustmark National Bank, which provides banking and financial solutions to individuals and corporate institutions in Florida, Mississippi, Tennessee, and Texas. TTM gross margin at 85.27% vs. industry average at 72.4%. TTM operating margin at 42.63% vs. industry average at 39.62%. TTM pre-tax margin at 27.4% vs. industry average at 23.64%. Diluted TTM earnings per share at 1.68, and a MRQ book value per share value at 19.05, implies a Graham Number fair value = sqrt(22.5*1.68*19.05) = $26.83. Based on the stock's price at $20.9, this implies a potential upside of 28.39% from current levels.

10. BOK Financial (NAS: BOKF) : BOK Financial Corporation, a financial holding company, offers a range of financial products and services to commercial and industrial customers, and other financial institutions and consumers. TTM gross margin at 89.46% vs. industry average at 72.36%. TTM operating margin at 51.31% vs. industry average at 39.66%. TTM pre-tax margin at 31.92% vs. industry average at 23.56%. Diluted TTM earnings per share at 4.06, and a MRQ book value per share value at 40.18, implies a Graham Number fair value = sqrt(22.5*4.06*40.18) = $60.58. Based on the stock's price at $50.0, this implies a potential upside of 21.17% from current levels.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.

Kapitall's Eben Esterhuizen and Rebecca Lipman do not own any of the shares mentioned above.

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