NEW YORK (
) -- Concerns about the
have weighed on regional bank stocks for some time, but there is some sentiment on Wall Street of late that fears of huge loan losses may be overblown.
Banks are expected to continue to suffer losses in several loan categories throughout 2010. But while the worst residential pain has likely already been felt, and overall consumer losses may have peaked last quarter, commercial real estate is believed to still have a ways to go.
Deutsche Bank analyst Matt O'Connor, for one, expects a peak somewhere in the second half of 2010. But he notes that the worst-quality loans won't be coming due until 2010 and beyond, and it's difficult to tell what the banking industry will look like at that point. The best-quality loans are actually coming due now, during the "worst of times" to refinance.
"It's both a positive and negative that CRE losses will be spread out over a longer period of time," says O'Connor, pointing out that: "It helps capital near term, but it pushes out normalized EPS."
As a result, regional bank stocks have been plagued by uncertainty of how big near-term write-downs will be, and how long it will take for bad commercial debt to filter through the system.
The easing of accounting standards last spring has only added to the guesswork. Whereas before banks were required to mark loan books down to market values, they now have more leeway in using actual cash flows to determine value. An optimistic management team may value its commercial loan book higher than an over-cautious one. Though neither is acting improperly, it adds to investor uncertainty.
Walt Mix consults with banks on valuation, deals and restructuring in the recession-battered state of California for the firm LECG. He notes that some commercial property values have dropped precipitously. For instance, a recent deal for property in the Los Angeles area garnered $250,000. The sellers had acquired it for roughly $1.4 million just a few years ago.
"Commercial problems are going to be around for awhile," says Mix, a former commissioner for the California Department of Financial Institutions.
Yet he also notes that clients have fared better with relaxed accounting standards. His LECG work includes visiting properties and evaluating cash flows to determine the actual value of a property. Sometimes he finds they're worth 40 or 50 cents on the dollar, rather than the 10 cents they'd sell for in the debt market.
FBR analyst Paul Miller says investors should buy banks with heavy commercial real-estate exposure whose stocks have been beaten up. He believes commercial problems will be more "manageable" than more widespread residential and consumer pain, because values were less inflated and borrowers have more reliable cash flows to pay down their debts than jobless consumers.
"We believe CRE losses will continue to rise," Miller says in a report on Thursday. 'In many cases, however, we believe this risk is less than warranted by current valuations."
Among his top regional picks are
Fifth Third Bancorp
He believes these companies have bolstered capital levels more than enough to handle imminent losses. (Others say
are undervalued, and set to to outperform as well.) Miller, however, remains cautious on banks that have not boosted capital dramatically, such as
, or are too richly valued to reflect ongoing credit stress, like
Morgan Stanley weighed in on Thursday, outlining its view of how the economic recovery will impact commercial real estate in 2010 in a research note to clients. The firm advanced its belief that "property values have bottomed, but the recovery will be multi-staged and gradual," and characterized commercial real estate as "only a moderate headwind for the economy."
The comments seemed to spark some buying interest as most of the companies Morgan Stanley listed as those who will benefit most if its bull-case scenario plays out rallied sharply in Thursday's session, including Regions Financial, Zions Bancorp, and Fifth Third.
That bull-case scenario calls for for property cash flows to resume "solid" growth in the second half of 2011 in response to a "robust" economic recovery. The firm's base-case scenario sees cash flow declines through the 2010-2011 period, reflecting a "sustainable but modest" recovery.
Written by Lauren Tara LaCapra in New York