4 of Banking's Blue Chip Stocks

By Markets Fool.com

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In the world of stocks, the term "blue chip" stocks is thought to have derived from the game of poker, where blue chips were once the most highly valued chips a player could acquire. Applied to bank stocks, the term refers to the biggest and best-known companies in the industry.

The most popular way to assess a bank's size is by looking at its balance sheet -- and, more specifically, the total value of the assets it holds. Twenty years ago, a bank was considered big if it had a few billion dollars' worth of assets on its balance sheet. Fast forward to today, and that figure is now in the trillions.

As of the first quarter of 2015, four banks had more than $1 trillion in assets on their balance sheets. JPMorgan Chase leads the way with $2.6 trillion in assets. Bank of America comes in second with $2.1 trillion. And Citigroup and Wells Fargo round out banking's most blue-chip stocks, with assets of $1.9 trillion and $1.7 trillion, respectively.

For banks, size offers numerous benefits. First and foremost, it allows a lender to diversify its asset portfolio. Three decades ago, when banks were still largely prohibited from branch and interstate banking, virtually every major lender in Texas failed because their assets were, one way or another, dependent upon the success of the oil industry. As a result, when oil prices fell off a cliff in the early 1980s, so too did the Lone Star State's banking industry.

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The situation today is dramatically different. Legislative changes in the late 1990s opened the door for lenders like Bank of America, Wells Fargo, and JPMorgan Chase not only to acquire nationwide branch networks but also to veer into the previously prohibited field of investment banking, and since then banks like these have been able to markedly reduce their exposure to any particular activity, industry, or geographical region.

During one of Bank of America's latest conference calls, for instance, its chief financial officer, Bruce Thompson, estimated that the North Carolina-based bank had total exposure to the oil and gas industry -- which is going through a repeat of the early 1980s -- of $23 billion. During the 1980s oil crash, that amount of exposure would have sunk Texas' one-time largest bank, First Republic Corporation. However, today, that figure pales in comparison to Bank of America's $250 billion in shareholders' equity.

Another benefit of size is that it allows a bank to exploit economies of scale. While this doesn't always play out in practice, bigger banks can theoretically operate much more efficiently than smaller banks because the former can spread their general and administrative costs over a larger revenue base. In the FDIC's latest Quarterly Banking Profile, for instance, banks with more than $10 billion in assets on their balance sheet spent an average of 62.4% of their net revenue on operating expenses, while banks with $1 billion to $10 billion in assets spent 65.1%. As you can see in the chart below, this relationship holds true as you look at even smaller banks.

Finally, it has long been assumed that a bank, once it becomes big enough, is "too big to fail." We saw this in the latest crisis when the federal government supported Bank of America and Citigroup in particular, both of which would have failed without taxpayers' assistance. But it's important to appreciate that while certain banks are indeed too big to fail, that doesn't mean their shareholders are immune to significant losses. Indeed, even though the crisis is now more than seven years in the past, shares of Bank of America and Citigroup still trade 71% and 90% below their 2007 levels, respectively.

While there are obvious benefits to investing in blue chip bank stocks, it isn't a panacea for investors looking for safety and security over the long run. To get this, as I've discussed at length elsewhere, requires a deeper dive into a bank's culture of expense and risk management. That being said, one must begin their search for great stocks somewhere, and a good way to start digging into any industry is to look at the successes and failures of its leading firms.

The article 4 of Banking's Blue Chip Stocks originally appeared on Fool.com.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.