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Bank Stocks Have Up to 25% Upside in 2012: Analyst (Update 1)

Bank stocks article updated with additional analyst commentary and stock market action.

NEW YORK ( TheStreet) -- Bank stocks are getting off to a great start in the new year and analysts at RBC Capital expect the party to continue through 2012, as the economy and fundamentals improve, dividends and buybacks increase and valuations remain attractive.

In a report on Tuesday, the analysts said that investors could see "meaningful upside" from current valuations, with bank stocks poised to rise 20% to 25% over the next 12 months.

Fifth Third Bancorp (FITB - Get Report), PNC Financial Services (PNC - Get Report) and Wells Fargo (WFC - Get Report) are among RBC's top picks for 2012 for their strong revenue generating potential, along with REIT Annaly Capital Management (NLY - Get Report).

"Bank stocks should reflect higher valuations as credit quality improvement, loan growth, and capital generation eventually lead to normalized earnings at some point in late 2013," the team led by Gerard Cassidy wrote in a note. "Assuming that interest rates remain low deep into 2013 and the industry's total loan growth averages 4-6%, return of capital strategies will surface as critically important in driving bank stock valuations higher, in our opinion."

The analysts believe that banks in a new normal environment can deliver a return on assets of 1% and a return on equity of 10%, which should typically command a multiple of at least 140% to 150% of book value. Bank stocks currently trade at an average 100% of book value, the analysts note, offering considerable upside.

While the European slowdown caused by the sovereign debt crisis will continue to be an overhang in the U.S., the analysts do not expect it to push U.S. into a recession.

RBC forecasts earnings of the top 20 banks to rise 33% in 2012 versus an estimated 15% in 2011.Loan growth is expected to be in the range of 4% to 6% driven by commercial loan growth.

RBC is not the only research house to get bullish on banks. Barclays Capital also released a report on Tuesday echoing many of RBC's views.

Catalysts for bank stocks could be capital returns, a mortgage settlement, the potential lifting of the European short sale ban and the presidential elections. "Banks stocks tend to outperform in presidential election years; more so when a Democrat is replaced by a Republican one," a team of analysts led by Jason Goldberg wrote in a report.

Barclays recommends investors take positions in larger banks rather than smaller ones given relative valuations, their lower exposure to net interest income, larger customer/cost base to spread increased regulatory costs. The analysts do not expect much by way of deal activity, which would be a potential catalyst for regional banks.

The analysts prefer Citigroup (C - Get Report) and JPMorgan Chase (JPM - Get Report) over Bank of America (BAC - Get Report). Among the super regionals Capital One Financial (COF), PNC Financial, USBancorp (USB) and Wells Fargo stand out; and within regionals the analysts expect City National (CYN), Fulton Financial (FULT), M&T Bank (MTB), and TCF Financial (TCB) to outperform.

Shares of Citigroup were climbing more than 7% on Tuesday, the first trading session of the year. Bank of America and JPMorgan shares were up by more than 4% each while Wells Fargo shares was climbing 3%.

--Written by Shanthi Bharatwaj in New York

>To contact the writer of this article, click here: Shanthi Bharatwaj.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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