Despite uncertainty about the eventual impact of major regulatory reform for the financial sector—and fears that further losses on bad commercial real estate loans loom—investors seem to be embracing bank stocks more willingly now.
The KBW Bank Index (BKX), a capitalization-weighted index comprising 24 geographically diverse stocks of national money center banks and large regional banks that is maintained by Keefe Bruyette & Woods, was up 20.4% year-to-date through Mar. 16 after jumping 129% between its Mar. 6 low and Dec. 31, 2009. For all of 2009, however, the index was actually down 3.6%.
Keefe Bruyette's equity analysts prefer larger banks that have repaid money they received under the Troubled Asset Relief Program (TARP) and are further advanced than smaller banks in providing for and taking losses. KBW now has an outperform rating on all large banks, and its favorite picks are Bank of America (BAC), JPMorgan Chase (JPM), U.S. Bancorp (USB), and BB&T (BBT), all of which were upgraded from a neutral rating over the course of 2009. But the stocks that have appreciated most in recent weeks are those that generally haven't yet repaid TARP money and that are perceived to be more vulnerable to further commercial loan losses, such as Regions Financial (RF) and SunTrust Banks (STI), says Jefferson Harralson, an analyst at KBW. For the year so far through Mar. 16, Regions shares were up 42% and SunTrust shares were up 35%.
"Those are more of a risk trade, in that investors are sensing that risk is diminishing, that we're farther through the credit cycle," he says.
Investors may be focused on bank earnings, which are expected to "rebound strongly as banks stop adding to loan loss reserves in 2010 and net interest margins benefit from the Fed holding interest rates unchanged and a steep yield curve through 2010," according to a Mar. 12 research note from Bank of America. David Bianco, chief equity strategist at BofA, said he prefers the large universal banks based on their higher loss reserves, smaller exposure to commercial real estate, and more diversified revenue streams from the capital markets, and he favors companies with a market cap of at least $20 billion.
With credit costs expected to moderate over time, Bianco said he sees banking as "big business" and suggested that investors overweight financials in their portfolios.
Investment banks that are leveraged to the capital markets are probably undervalued now, since "we're in the midst of what looks like a really strong capital markets environment," says Jeffrey Harte, an analyst who covers big banks at Sandler O'Neill & Partners in Chicago. Money center banks such as JPMorgan and Citigroup (C) also are likely undervalued now that major operating challenges seem less menacing, he adds.
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