Chances are good that the third-quarter earnings season will be a good one for the nation's banks. What's unclear is whether it will do anything for bank stocks.
Few banks have issued earnings warnings this month, which is a positive development, given that Wall Street is already expecting most banks' earnings to be substantially higher than in the year-ago quarter.
The problem for investors is that much of the expected good news has already been priced into bank stocks.
The Philadelphia KBW Bank Index is up 24% for the year, compared with an 18% gain for the
, of which bank stocks make up 20%. Moreover, the bank index, trading around 930, is at its highest level in two years.
J.P. Morgan Chase
, to name a few, are all trading right around their 52-week highs. The price-to-earnings ratio for many bank stocks is in the mid- to high-teens, right around the historic average for the sector.
To buy bank stocks now is to have confidence that the sector is on the verge of churning out double-digit earnings growth on a regular basis. But it's too soon to say if that kind of growth is in the cards.
This quarter, even with Wall Street's heightened expectations, the banking sector is expected to generate 8% growth in earnings per share, according to analysts at Fox-Pitt, Kelton. That's down from the second quarter's 9% growth rate.
While consumer lending remains strong, banks have yet to see a revival in business loans. A bank executive at Atlanta-based
, in a conference call last week, said "corporate lending remains stagnant." That may indicate U.S. businesses still aren't sold on the strength of the U.S. economic recovery.
"We're still looking for signs of commercial loan growth," said Mark Morgan, a Standard & Poor's bank analyst. "It is taking longer than you saw in the '90s."
The threat posed by the bad loans banks made to the telecom and energy sectors is easing, and that means fewer hits against earnings. But banks also can expect to post smaller gains on their investments in mortgage-backed securities due to this summer's rapid rise in interest rates, which tends to make those investments less valuable.
Additionally, the rise in long-term rates will no doubt lead to a slowdown in the red-hot mortgage banking business -- something that has juiced earnings for many regionals and thrifts.
Shares of Citigroup and J.P. Morgan have rebounded from the pasting they took last year because of their involvement in a myriad of corporate scandals. But the mutual fund trading scandal at
Bank of America
threatens to keep a lid on shares of the nation's third-largest bank, as investors worry about the damage to the reputation of the Charlotte, N.C.,-based lender.
So what's the eager bank investor to do?
One strategy is speculating in stocks of banks that could be buyout targets when the merger market heats up. Right now most of the deals in the banking sector have been small ones, with big banks picking up small lenders in niche markets.
But most expect that scenario to change if the economic recovery picks up next year. The banking sector's two biggest players, Citigroup and J.P. Morgan, are on record as saying they'd like to do some acquisitions in the coming year.
The list of potential acquisition targets includes Fleet,
Others, several industry experts said, could be
. Even Wells Fargo could find itself on the list of buyout candidates if it doesn't make an acquisition first.
Some thrifts also could make for appealing targets, such as New York-based
. Credit card lender
is also a frequently mentioned buyout target.
The acquirers will be looking to do deals that bulk up their retail presence in a geographic region, gain a foothold in a new city, or add to a sizable asset management business.
But investors speculating on buyout candidates should be warned that not everyone thinks this is a wise strategy. Some financial services money managers said the days of the oversized premium in banking deals may have died with the last bull market.
Michael Stead, a portfolio manager with Wells Capital Management, said he expects premiums in bank deals to range in the 8% to 10% range in the near future.
"In the past we've seen gross overpayments for banks," said Stead, whose fund invests mainly in financial services companies. "I'm more inclined to own banks on their merits."