NEW YORK ( TheStreet) -- For bank stock investors, uncertainty is now the name of the game and will likley grip the sector for the foreseeable future. "Year-to-date, banks have been the best performing asset class; since April,
they're the worst performing asset class," Eric Heaton, managing director and co-head of financial institutions group at Deutsche Bank, ( DB) said earlier this week. Heaton was speaking during a panel presentation at the SNL Financial Bank M&A Symposium held in New York. The Keefe, Bruyette & Woods bank index ( BKX), which tracks the top 25 U.S. banks, is down nearly 17% since April 30 after posting a roughly 30% rise to that point. As of this date the BKX is up roughly 8% for the year Despite some of that uncertainty alleviating with the signing of the Dodd-Frank Act by President Obama in July and new international capital standards coming out of Basel III last month, bank stocks are still in flux. According to Jim Meyer, the chief investment officer at Tower Bridge Advisors in West Conshohocken, Pa., that's not about to be alleviated anytime soon. "There are two overriding issues with the banks right now: FinReg and the flattening yield on then U.S. Treasury bond that both work against banks stocks until they're resolved," Meyer says, adding that his firm is underweight the bank sector. "The environment is still hostile and will likely be hostile for longer than not and so we stay away." Meyer continued: "We know that as FinReg rules are contemplated and written that there are going to be a lot of speed bumps and other issues along the way. But the other issue just fundamentally, banks borrow at one rate and lend at another and when the yield curve flattens, they make less money." "The banks are going to be playing defense for a lot longer until they know the rules of the game. And it's not really the economy. ... The ability to clean up yesterday's problem and start anew just gets stretched out for longer," Meyer says.
For an investor who must have banks in their portfolio, fundamentally they should look for institutions with "significant foreign operations, smaller banks that never took from the
U.S. government's Troubled Asset Relief Program and didn't make some of the foolish mistakes of other banks," Meyer says. However, "they're all drawn into the same morass and few -- if any of them -- are likely to outperform," he adds. "So in the financial arena, we would look to other places -- asset managers or insurance brokers or something simply less affected and to underweight the banks." The credit crisis has changed the way analysts perceive bank stocks, and industry numbers back-up the general feeling that by "getting back to basics" the sector is setting itself up for a long healthy period. Todd Hagerman, senior banking analyst at Collins Stewart, says it's likely that the sector is going to be "range bound" for the foreseeable future. "What's starting to weigh on the group right now are earnings expectations that remain too high going into 2011 and no growth in sight -- it makes it difficult for these stocks to move appreciatively higher," he says. "It's really difficult to get excited right now." Third-Quarter Bank Earnings Preview That being said, Hagerman is more optimistic of next year and beyond. "There are a number of potential catalysts out there for the group," he says, noting that industry capital standards have been provided a baseline through Basel III. "It sets up at least the larger banks to begin thinking more actively about how managing capital over next couple of years. That's a positive." Hagerman added that given the slow growth period banks are facing, bank stock valuations are likely to get some support by further consolidation in the sector. Still for long-term investors, Hagerman's preference is to stick with high quality names, such as JPMorgan Chase ( JPM), PNC Financial ( PNC) or Wells Fargo ( WFC). These are companies that are "well capitalized, they don't have TARP money and they're likely to be either aggregators or the fact that they are focused on offensive as opposed to defensive," Hagerman says. Investing in bank stocks is likely a play on the economy, but many companies, now that they have seen the worst in credit quality have positive momentum building. Tom Brown, the CEO of Second Curve Capital, a hedge fund that invests solely in the financial services sector, and the co-owner of Bankstocks.com , a niche banking blog, is much more optimistic.
Whether economic growth is 1-3-5% is of minor factor relative to the improvement of credit quality that's going to take place," Brown says. "But
even in a 1% GDP environment credit quality is still going to get better and the guys that aren't profitable are still going to return to profitability." Brown continues: "We've only get opportunities like this -- at least I've only seen it -- once every 20 years." Three companies that Brown is particularly bullish on are Synovus ( SNV), Taylor Capital ( TAYC) and NewStar Financial ( NEWS). "All three of those companies are losing money but show further improvement in credit quality" and are priced at discounts to their tangible book values, he says. "I think that each of them can double over the next 18 months." --Written by Laurie Kulikowski in New York. To contact the writer of this article, click here: Laurie Kulikowski. To submit a news tip, send an email to: firstname.lastname@example.org.