Financial stocks have been a disaster for years. Banks in particular have been out of favor with every kind of investor except those who short stocks for a living. They've loved the banks. With this year about to close, how do things look for financials, especially banks?
One positive is interest rates. They're almost guaranteed to stay low with the Fed stating that it doesn't see raising rates until 2013. With low costs for deposits, banks will be able to fund loans and make a wide spread. Right now most banks are making at least 3% to 4% on their loans, depending on the type, because their cost of funds is so low. Expect spreads to stay wide and at least profits from interest income to stay high.
Another plus for banks is that most of the bad news seems baked into current prices. When many are selling well below book value (Bank of America (BAC) is at .28....Citibank (C) is at .49), investors have punished these stocks severely for their inept management and bad loans. With Bank of America, there's a huge cloud still overhanging. It has a name: Countrywide. The bank bought the mortgage lender and didn't realize just how bad things were. Now it's got lawsuits that could run into billions. Until that gets resolved with an absolute number investors can use for evaluation purposes, BAC will have a hard time finding love. Once it does, however, if the number isn't too startling, expect the stock to rebound since most of the time investors sell to the worst case scenario.
Some of the negatives: capital raising may be high on management's agenda with new capital rules most likely next year as stress testing gets more onerous. No one wants to relive the credit crunch. In order to avoid that, the most obvious answer is to have banks sitting on more capital. Only the largest banks will most likely be required to play by the new rules since they're the ones denoted as "too big to fail" last round. But if they go back to the markets for more capital, at these low valuations, the dilution will sink the stocks lower.
On the positive side is that banks have lots of cash to lend. Once the economy starts to gain more traction, demand for homes, expanding businesses, and cars, to name a few that require more cash, will escalate. Banks have the money to accomodate an expansion and will generate even more profits than currently (with the exception of those nasty one time lawsuits so many seemed to be involved in....they also will pass).
It's the banks with solid operating earnings (Wells comes to mind (WFC) and JP Morgan Chase (JPM)), that should benefit the most next year. If they're already making good money, they'll do even better in a solid economy. And next year could be the year growth begins to accelerate. Why? Just because economies go in cycles and we've been down in the trough and are beginning to show signs of improvement, nothing great, but at least the economy is expanding, not contracting, and unemployment is down.
With low interest rates, better employment and lots of cash, expect banks to do better next year. The best performing ones will be the cleanest, most profitable now. They'll be reaping any benefits that a more robust economy will generate. But if the economy slides backward, banks won't be going anywhere. Their downside is somewhat limited now because of investors' avoidance, but once they begin to see some hope, bank stocks could move higher, very fast. Most are priced for the worst case now.
- Ted Allrich
December 6, 2011