NEW YORK ( TheStreet) -- The Dubai debacle has prompted investors, once again, to consider the state of the credit crisis and global banks. Dubai's state-controlled holding company last week sought a standstill agreement with creditors and an extension of loan maturities until at least May 30, the latest credit bubble to burst more than a year after Lehman Brothers died and AIG ( AIG) was put on life support. Still, three of the four biggest U.S. banks -- Bank of America ( BAC), JPMorgan Chase ( JPM), Citigroup ( C) and Wells Fargo ( WFC) -- are excellent choices for long-term investors. The following is a breakdown of each of the four banks, and their prospects as investments.
Headwinds include the possibility that Bank of America may need to raise capital to pay back the government. Then again, dividends on preferred shares issued to the government amount to $563 million per quarter. In a report reiterating his company's "buy" rating on Bank of America, Sandler O'Neill analyst Jeff Harte said "the opportunity to reduce preferred dividends is likely to outweigh the dilutive impact of an increased share count." Another event that could lead to capital increases among large domestic banks is the January implementation of statements 166 and 167 from the Financial Accounting Standards Board, which cover sales accounting for off-balance sheet assets. The big four securitized significant portions of their mortgage and credit-card portfolios in recent years, selling assets to off-balance sheet conduits. The new rules will force companies to move most of those assets back to the balance sheet. In a recent regulatory filing, Bank of America estimated a "net incremental impact on total assets" of about $121 billion. With coming changes in management and accounting rules, and the government monkey on its back, the road will be rocky over the short term. However, boasting the biggest domestic deposit franchise, along with Merrill Lynch, Bank of America is an excellent recovery play. The company's stock has risen 10% this year.
The company's $3.6 billion in third-quarter net income translated into a return on average assets (ROA) of 0.71%, better than 2008's 0.21%, but behind the 1.06% return in 2007 and 1.04% in 2006. Loan losses have been increasing, as JPMorgan's annualized ratio of net charge-offs to average loans for the third quarter was 3.75%, up from 3.38% in the previous quarter and 1.77% a year earlier. JPMorgan's reserve build has kept pace, with loan-loss reserves covering 4.59% of total loans as of Sept. 30. Regarding the implementation of FAS 166 and 167, Barclays Capital analyst Jason Goldberg estimated that JPMorgan will bring about $100 billion in assets to its balance sheet, which wouldn't come close to forcing the company to raise additional capital. JPMorgan's shares trade at 1.6 times tangible book and 12.6 times earnings. The stock sold for 2 times tangible book at the end of 2007, 2.5 times in 2006 and 2.4 times in 2005. The year-end price-to-earnings ratios were 12.7 in 2007, 9.6 in 2006 and 13.1 in 2005. As such, JPMorgan's shares are inexpensive, even though they've risen 31% this year.
Other analysts have a more positive outlook for Wells Fargo's shares, including Oppenheimer's Chris Kotowski, who supported an "outperform" rating for the company, with a price target of $36 based on discounts applied to an estimate of "normalized earnings" of $4.71 in 2012, and a price-to-earnings ratio of 12. The shares are trading at about 12.1 times earnings and 1.4 times book value. SNL Financial couldn't provide a price-to-tangible book value estimate for Wells Fargo based on the company's September financial report. The stock was selling at 2.9 times tangible book at the end of 2007 and 3.5 times in 2006. In a recent regulatory filing, the company estimated the implementation of FAS 166 and 167 would bring $48 billion in assets on to its balance sheet. More importantly, Wells Fargo has yet to repay the $25 billion in government bailout money. After government stress tests on the largest 19 domestic holding companies were completed in May, Wells Fargo raised $8.6 billion in a public offering, exceeding by $6 billion the target set by regulators. Wells Fargo had the highest regulatory tier 1 leverage ratio among the big four -- 9.03% as of Sept. 30 -- but also the highest level of nonperforming assets, comprising 4.43% of total assets. Nonperforming loans shot up after the company acquired Wachovia in last year's fourth quarter but have risen more sharply over the past two quarters. The ratio of net charge-offs to average loans was 2.39% for the third quarter, and the company kept ahead of the loan-loss pace, with reserves covering 2.86% of total loans as of Sept. 30.
Wells Fargo's acquisition of Wachovia doubled the company's size, diversified its revenue base and put it in second place for domestic deposits after Bank of America. While the company's nonperforming loans are cresting, and it will take some time for the company to repay the government, Wells Fargo has posted decent earnings for three quarters and is rebuilding its capital ratios. Wells Fargo's stock has fallen 7.9% this year.