NEW YORK ( TheStreet) -- New Year's Eve is a great time to celebrate a nice recovery year for banks stocks, and to look ahead by identifying names that are trading at low multiples to forward earnings estimates.
If you were picking stocks a year ago, after the KBW Bank Index (I:BKX) sank 25%, with Bank of America (BAC - Get Report) dropping 58% during 2011 and Citigroup (C - Get Report) falling by 44%, there was a host of large-bank plays trading at significant discounts to book value. Bank of America's stock was trading for just 0.4 times tangible book value at the end of 2011, while Citigroup traded for 0.5 times tangible book value.
Playing the big names trading below book was certainly a winning strategy for 2012, with Bank of America returning an amazing 105% through Friday's close at $11.36, while Citigroup was up 48% year-to-date through Friday's close at $39.01. Then again, for longer-term investors, Bank of America's shares were still down 14% from the end of 2010, while Citi was down 21% for the same period.
With the industry continuing to build capital, and with the strong recovery this year, there are many fewer big banks trading below book value. Bank of America now trades for 0.9 times tangible book value, but the shares look rather expensive, trading for 11.8 times the consensus 2013 earnings estimate of 96 cents, among analysts polled by Thomson Reuters. A silver lining for the shares is that the consensus 2014 EPS estimate is $1.25, portending a relatively large jump in earnings another year out, as the company works to cut expenses. Investors are also looking for a significant boost in the company's return of capital, following the next round of Federal Reserve stress tests, which will be completed in March.The increased return of capital though higher dividends and share buybacks will be a major theme for most of the big banks in 2013. While many investors rightly fear that the U.S. economy could slip back into recession without a compromise in Washington to avoid the Fiscal Cliff, the Fed's stress tests include a "severely adverse scenario" for a difficult recession in 2013, and most bank analysts think that the large banks will still be approved for dividend increases and significant buybacks. The banking industry will also continue to face a rough interest rate environment, as the Federal Reserve is maintaining its "highly accommodative" policy of making large monthly purchases of mortgage-backed securities and U.S. Treasury securities in order to keep long-term rates at their historically low levels. The short-term federal funds rate has been kept in a target range of zero to 0.25% since late 2008, meaning most banks are feeling the squeeze, as they have already realized most of the benefits of lower funding costs, while their assets continue to reprice at lower rates. Banks are looking to offset the declining net interest margins through continued strength in fee income from the mortgage refinance wave, with gains on the quick sale of newly originated loans to Fannie Mae (FNMA) and Freddie Mac (FMCC). Improving credit quality will also boost earnings through the release of loan loss reserves, although this is expected to subside during 2013, with some banks beginning to build reserves again. While many banks will still not be back to "normalized earnings" performance during 2013, the combination of stronger capital, stronger liquidity, the housing recovery and credit improvement, expense reductions, and capital turns, all bode well for a continued recovery of bank stock prices. With low multiples to book value having less meaning at this point in the credit cycle, we have used data provided by Thomson Reuters Bank Insight to isolate the 10 actively traded bank stocks -- with average daily trading volume of over 50,000 shares -- trading at the lowest multiples to consensus 2013 operating earnings estimates. Here they are, in order from the highest forward P/E to the lowest:
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