Bank Stocks Poised to Ride Out Recession

NEW YORK ( TheStreet) -- Bank stocks are pricing in a double-dip recession, but industry analysts contend that the impact of a downturn this time around might not be as severe as first thought.

The consensus is that banks, especially the big four- Bank of America ( BAC), Citigroup ( C), JPMorgan Chase ( JPM) and Wells Fargo ( WFC)- have much stronger capital and liquidity levels, indicating that they have a much stronger capacity to absorb losses.

>>Citigroup Selloff Is Overdone

Barclays Capital Credit Research analyst Jonathan Glionna notes that the total tangible common equity of the four largest U.S. banks has grown from $248 billion at the second quarter of 2007 to $471billion at the end of the most recent quarter. "If a downside scenario were to materialize, we would expect the four banks' combined quarterly preprovision earnings of more than $30 billion to offset a substantial portion of loan losses or legal charges as they occur; however, if earnings streams diminish, the major banks would still have this large pool of capital to absorb losses," he said in a note.

What's more, while another recession will undoubtedly stall loan growth, the credit losses might not be as exaggerated this time around.

"At this point, we do not see the current environment as indicative of meaningfully higher-than-expected credit costs," Goldman Sachs analysts wrote in a report.

They cite three reasons.
  • First, the majority of levered loans underwritten prior to this credit cycle have already been charged off.
  • Second, loans that have been more carefully underwritten in the 2008-2010 period are now a larger part of the book.
  • Finally while the level of unemployment remains high, there is unlikely to be a rapid flow into unemployment in the manner seen in 2008-09 when the unemployment rate doubled from 5% to 10%.

Raymond James analyst Anthony Polini makes a similar argument, suggesting that even if a recession were to occur, it is unlikely to make a big dent in bank profitability given that it would follow a period of anemic growth. "If we do have a recession next year, it is not going to look much different from this year's recovery," Polini told TheStreet. "The U.S. economy will be falling off a cliff that is only a foot high, not a mile high like it was before. There have been no excesses to speak of."

Analysts have certainly been taking down their estimates to reflect a longer period of low interest rates and limited growth.

Goldman Sachs cut price targets and estimates for Bank of America, Citigroup and 20 other banks on Thursday. On an average, they reduced 2012 and 2013 per-share earnings estimates by 7% and 10% respectively.

It also revised industry loan growth estimates to 2.5% to 3% in 2012 from its prior estimate of 4%,. The estimates exclude run-off portfolios, which for the average bank is a 2% annual growth headwind.

Nomura analysts Brian Foran and Glenn Schorr conducted an earnings stress test that implied there 2012 EPS could fall as much as 40% assuming a 5% drop in loan and fee growth, lower margins and no reserve releases.

But even so the analysts do not seem in a rush to make deep cuts to estimates. "We are not saying our estimates need to fall that much―it is meant as a stress test, and the real point is banks are still profitable. Plus there are always offsets, e.g. as rates fall, some banks look set to make a lot more money on mortgage refi," Nomura analysts said in the report.

With stocks trading at deep discounts to tangible book values , analysts figure the downside cannot be much.

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--Written by Shanthi Bharatwaj in New York

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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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