Bank Stocks Gets Cheaper, But Risks Remain

BOSTON (TheStreet) -- The nation's two biggest banks, Bank of America (BAC) and Wells Fargo (WFC), will let investors know if they've overcome their problems with troubled assets this week when they report their second-quarter results.

More than two years have passed since bank stocks helped bring major benchmarks to a 12-year low. Bank of America and Wells Fargo shares have doubled since March 2009 as the companies shed bad mortgages and shored up their balance sheets with the help of government aid. Still, analysts are betting that the banks aren't out of the woods.

Bank of America stock is down 24% this year, making it the worst-performing bank in the KBW Bank Index, which tracks 24 U.S. banks. Wells Fargo shares have lost 12%, beating the 11% decline of the KBW index. The Standard & Poor's 500 Index has gained 5% this year.

The slowing U.S. economy and Europe's debt crisis are also adding to woes in the financial sector. A weak economy is dampening demand for loans as companies become more cautious. The debt crisis in Europe has the potential to shake bank stocks around the world, even if they don't hold sovereign bonds.

Bank of America is the largest U.S.-based financial holding company with global assets of $2.3 trillion. The Charlotte, N.C.-based bank acquired Merrill Lynch and Countrywide Financial in 2008, leading to some unexploded bombs in its loan portfolio. For fiscal year 2011, analysts estimate that Bank of America will lose 16 cents per share, including a 90-cent loss in the second quarter. But the bank is expected to turn its business around next year to earn $1.68 per share.

"Bank of America's recent bold actions to contain and reduce its potential liability from soured mortgages should go a long way toward clarifying its total exposure to the U.S. housing bust," Standard & Poor's wrote in a research note.

Analysts appear to be optimistic about Bank of America's prospects. Eight analysts rate the stock "buy," 10 rate it "buy/hold" and 14 say to "hold" the stock, according to Standard & Poor's.

Standard & Poor's analyst Eric Oja rates the company "strong buy" with a five-star rating, the firm's highest rating. S&P considers Bank of America shares "attractively priced."

"The main risk for these large banks, in our view, is fee income and loan growth," Oja wrote in a research note. Government regulations enacted during the past year related to credit and debit card transactions has hurt fee income and increased costs.

"Bank managements remain cautious about loan growth, due to persistent economic uncertainties, which are likely causing small and mid-size employers to delay hiring and capital spending," he wrote.

Wells Fargo is in better shape than Bank of America, which swallowed the poisonous mortgage portfolio of Countrywide Financial two years ago. Timothy Sloan, chief financial officer of the San Francisco-based bank, said last month that demand for new business loans has remained steady despite the slowing economy.

Wells Fargo is expected to report second-quarter earnings of 54 cents a share, down from 67 cents in the first quarter and 55 cents a year earlier. The company is expected to report earnings of $2.77 a share for 2011. For fiscal year 2012, analysts estimate that it will post earnings per share will grow by 22% to $3.39 per share.

Analysts are all over the map on Wells Fargo, with six "buy" ratings, 13 "buy/holds," 9 "holds," two "weak holds" and one "sell."

S&P has Wells Fargo rated "hold," noting that it too, is still struggling with its Wachovia acquisition, a deal brokered during the financial crisis in 2008.

Oja writes that Wells Fargo is seeing "a continuing run-off of legacy loans, (so as a result) we expect net interest income to fall 4.3%, following a 3.4% decline in 2010."

"Also, (Wells Fargo's) funding costs are among the lowest in the industry, a positive, but have little room to fall further, a negative," he said.

Giving signs of promise for the still recovering banking sector, investment banking giant JPMorgan Chase ( JPM) with a market value of $160 billion, reported second-quarter earnings last Thursday that beat Wall Street's expectations by 6 cents per share. It also reported revenue growth of 7%, when the Street was predicting a decline of 2%. Still, JPMorgan Chase's shares are down 7% this year.

The drops in bank stocks might create a buying opportunity for investors who are confident that U.S. economy will gain steam soon. Shares of Bank of America and Wells Fargo are trading at less than 10 times earnings, making them cheaper than the average bank stock. Members of the KBW Bank Index have an average price-to-earnings ratio of 13.

The Fairholme Fund ( FAIRX) has 5.6% of its assets invested in Bank of America, the largest bet on the company by an actively managed fund. Fund manager Bruce Berkowitz, who's known for his contrarian bets, has filled his $15 billion fund with financials, led by American International Group ( AIG).

While the banks are struggling now, their size and geographic reach will help them mobilize as loan demand picks up. When the economy rebounds, large banks will start minting money again.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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