Updated with analyst commentary.
NEW YORK (
) -- It is hard to make a case for bank stocks these days. Even analysts have almost given up.
With the European crisis wildcard, weak revenue, stiff regulations and ongoing litigation it is hard to predict what lies ahead for the global economy and for U.S. banking.
Still, heading into 2012 there are at least three positive forces pushing bank stocks.
1. Analysts are not too optimistic:
And that's a good thing. Few analysts got it right in 2011. Most analysts began the year bullish on bank stocks that were trading at seemingly cheap valuations, even as the recovery in the economy seemed to be underway.
But as the economic recovery stumbled and the European debt crisis escalated, bank stocks plummeted. Still, analysts mostly stuck to their "Buy" or "Outperform" recommendations while simultaneously cutting estimates, arguing that valuations captured almost all the downside. But stocks have only slid further. Investors may have been better off avoiding sell-side analyst recommendations.
Rochdale Securities analyst Richard Bove ended up issuing a mea culpa in November. "I failed to understand that the fears in the market concerning banking were so great that the fundamental improvements in the economy, the industry, and companies like Bank of America and Citigroup would simply be ignored," Bove wrote in a report.
But more recently analysts have toned down their optimism, especially on the universal banks that have a big exposure to capital markets.
have seen steep downgrades not just for the fourth quarter , when trading revenues and mergers and acquisition activity was weak, but for 2012 and 2013 as well, on expectations that revenue pressures will exist as investment banks adapt to new regulations that rein in risk-taking.
continues to be a top pick among industry analysts, but mostly because of its high-quality, safe-haven appeal, which means analysts are still more defensive in their stock selection. Although many analysts expect
to provide significantly higher upside through capital returns in the coming years, the stock is still perceived as a high-risk bet that melts with every negative headline out of Europe.
Bank of America
has become a pariah among big bank stocks, conspicuously missing from analyst picks for 2012.
Even the sector view on banks across brokerage houses is pretty bleak.
Morgan Stanley has 50 picks for way upto 2015 and not one of them is a bank stock. Barclays Capital is also
The good news is that with analyst expectations so low and the market pricing in virtually every negative event, it might take relatively little for banks to positively surprise.
2. More dividends and buybacks to ring in the new year:
Banks are eager to return capital to shareholders , seeing little alternatives to reward shareholders as growth opportunities remain elusive. At a recent Goldman Sachs Financial Services conference in New York, almost all banks declared confidently that they would pass the Fed's harsh stress test in 2012 and reiterated their intention to increase dividends and buybacks.
Citigroup said it expects to generate $65 billion in excess capital in the next couple of years which it could return to shareholders in the form of dividends and buybacks. JPMorgan Chase expects to achieve its Basel III capital targets as soon as it can, but still has room for modest dividend increases and buybacks.
Big banks might face more limitations in getting the Fed's approval to raise their payout ratios substantially, but analysts say modest dividend increases and buybacks are likely, leading to a rise in dividend yield that could offer some support to valuations.
At smaller, regional banks such as
F.N. B. Corp
People's United Financial
, the dividend hikes and opportunities to deploy capital in M&A could be more substantial, as they are not subject to the same level of scrutiny as their larger counterparts, according to KBW.
Guggenheim Securities analyst Marty Mosby told
in a recent interview that he expects the dividend yield of banks such as
approaching 4% in 2012. "When you look at the dividend yield getting above 3%, this will be the first time we've been at that since we entered the financial crisis," Mosby told SNL. "So this is an inflection point when you can finally get your dividend yield back up above the 10-year Treasury as a group."
3.It's a European recession:
Even if the U.S. does have a recession sparked by the developments in Europe, its impact on banks is not expected to be as bad as the last one. The Fed's stress test in the spring will put that thesis to the test as it requires banks to prove that they can withstand losses in a truly dire scenario that envisages U.S. GDP declining by 8% in the first quarter of 2012.
That is a harsh scenario, considering that the most pain will likely be felt at the epicenter of the crisis in Europe rather than in the U.S. Most analysts believe that banks have built sufficient capital to pass the stress tests. If banks do sail through, it could bring back more confidence in the system.
Analysts also believe that underwriting standards have tightened considerably since the crisis, with the effect that banks may not see credit quality deteriorate as significantly as they did at the height of the crisis when lending standards were loose.
Meanwhile, bank stocks are priced for a recession, with many of them trading at substantial discounts to their book value, so a downturn in the economy won't come as a shock to investors.
None of this is to say that bank stocks are not a high-risk buy at this point. But 2012 might not be a complete washout for the sector either.
--Written by Shanthi Bharatwaj in New York
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