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5 Forces That Could Fire Up Bank Stocks in 2012

Despite management assurances about capital and liquidity levels, investors have, however, been skeptical about banks' ability to withstand another recession. If banks pass the test successfully, analysts expect investor confidence in banks to improve significantly.

The bigger story will be banks' ability to return more capital in 2012. Banks have expressed confidence that they will pass the test and be able to increase dividends/buybacks in the year ahead.

Bank of America is not a strong candidate for dividend increases but Citigroup is expected to increase its dividend in 2012 and return substantial capital to shareholders in 2013. JPMorgan has said it will manage modest dividend increases and buybacks even as it strives to achieve a target Tier 1 Capital ratio of 9% under Basel III.

3. Mortgage settlement: For more than a year, banks have been negotiating a settlement with Federal and state regulators over alleged improper foreclosure practices including robo-signing, where officers approved foreclosures without reviewing documents.

Banks are seeking a broad release from all mortgage-related litigation from states. The settlement is expected to top $25 billion and is likely to include cash payments to borrowers and principal modifications for troubled borrowers.

Bank of America is expected to take the biggest share of the settlement, while Citigroup may have a more limited exposure.

The talks hit a major setback in October 2011 when California State Attorney General Kamala Harris pulled out of the negotiations. Since California is considered the epicenter of the foreclosure crisis, mortgage servicers could continue to face significant liability from that state in the absence of a settlement.

That is why analysts say the market might be willing to swallow even an expensive deal so long as it puts an end to significant litigation from the states.

"While it's hard to judge without seeing it, we believe if the outcome doesn't include an egregious amount of money and is fairly encompassing, investors would be pleased to see this issue put to bed," Barclays Capital analysts wrote in a report Tuesday.

2. M&A activity: Deal activity has declined in the banking sector as potential sellers continue to hold out for better valuations, while potential buyers are unwilling to pay premium for banks amid a stricter regulatory environment for big banks.

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