5 Forces That Could Fire Up Bank Stocks in 2012

NEW YORK ( TheStreet) -- Bank stocks got off to a roaring start on the first trading session of the year. Will the rally continue for the rest of the year?

Bank analysts certainly seem bullish. But then they have been for the last two years, even though stocks have turned in a dismal performance.

The argument that bank stocks are "cheap" has not won over investors. Still, analysts argue that all the sector has been missing is a catalyst and in 2012 there appears to be several.

Here are some of the most commonly cited factors that will move bank stocks this year.

5. Progress on the European Debt Crisis: This is easily the biggest overhang on the valuations of the big banks, which not only have a direct exposure to European banks but also have material capital market operations that have been affected by severe volatility in the markets.

Should a credible plan emerge out of Europe- hope springs eternal- the upside to the universal and investment banks- Bank of America ( BAC), JPMorgan Chase ( JPM), Citigroup ( C), Goldman Sachs ( GS) and Morgan Stanley ( MS) could be substantial, according to analysts. These stocks have been beaten down with every negative headline out of the troubled Euro zone.

The looming threat of the collapse of the euro is still out there, however, and bank stocks remain highly correlated to news out of Europe. According to KBW analyst Frederick Cannon, investors will need to see more evidence that the U.S. economy can be successfully de-linked from Europe.

In other words, if the U.S. economy continues to show some sign of improvement even as Europe slips into recession, investors will once again focus on the fundamentals rather than the macro risks and bank stocks could get a lift.

4. 2012 CCAR: The Federal Reserve will be conducting its annual 2012 Comprehensive Capital Analysis and Review (CCAR) in first quarter of 2011 for banks with over $50 billion in assets.

Banks will have to show that they can continue to maintain a Basel 1 Tier 1 Capital of 5% even in the event of a severe recession in the U.S. and a global market shock that could result from a Euro meltdown.

Despite management assurances about capital and liquidity levels, investors have, however, been skeptical about banks' ability to withstand another recession. If banks pass the test successfully, analysts expect investor confidence in banks to improve significantly.

The bigger story will be banks' ability to return more capital in 2012. Banks have expressed confidence that they will pass the test and be able to increase dividends/buybacks in the year ahead.

Bank of America is not a strong candidate for dividend increases but Citigroup is expected to increase its dividend in 2012 and return substantial capital to shareholders in 2013. JPMorgan has said it will manage modest dividend increases and buybacks even as it strives to achieve a target Tier 1 Capital ratio of 9% under Basel III.

3. Mortgage settlement: For more than a year, banks have been negotiating a settlement with Federal and state regulators over alleged improper foreclosure practices including robo-signing, where officers approved foreclosures without reviewing documents.

Banks are seeking a broad release from all mortgage-related litigation from states. The settlement is expected to top $25 billion and is likely to include cash payments to borrowers and principal modifications for troubled borrowers.

Bank of America is expected to take the biggest share of the settlement, while Citigroup may have a more limited exposure.

The talks hit a major setback in October 2011 when California State Attorney General Kamala Harris pulled out of the negotiations. Since California is considered the epicenter of the foreclosure crisis, mortgage servicers could continue to face significant liability from that state in the absence of a settlement.

That is why analysts say the market might be willing to swallow even an expensive deal so long as it puts an end to significant litigation from the states.

"While it's hard to judge without seeing it, we believe if the outcome doesn't include an egregious amount of money and is fairly encompassing, investors would be pleased to see this issue put to bed," Barclays Capital analysts wrote in a report Tuesday.

2. M&A activity: Deal activity has declined in the banking sector as potential sellers continue to hold out for better valuations, while potential buyers are unwilling to pay premium for banks amid a stricter regulatory environment for big banks.

However analysts argue that consolidation in the sector is inevitable. "Negative operating leverage from record low interest rates and weak loan demand, should accelerate industry consolidation, in our view, as more banks realize they cannot deliver competitive returns on capital in this operating environment," Baird Equity Research analysts said in a report.

Baird expects US Bancorp ( USB) and BB&T ( BBT) to capitalize on attractive opportunities while weaker regionals such as Synovus ( SNV) and Regions Financial ( RF) are most likely acquisition targets.

1. Presidential elections: The Presidential elections could be a game changer for the financial services industry, although its impact will only likely be realized in 2013.

Analysts believe that the anti-Wall Street rhetoric in Capitol Hill would subside if Republicans take more control. "Historically banks have done relatively well in election years, regardless of the outcome," Barclays Capital noted in a report. Bank stocks have risen by an average 10% in the Presidential election years since 1937, double the S&P 500 average of 5%, the analysts noted. "Bank stocks rose in 10 out of the past 12 election years, outperforming in 8 of those. Furthermore, in each of the 4 years in which a Republican president unseated a Democratic one (1952, 1968, 1980, 2000) bank stocks finished higher (outperforming in 3 of those), rising an average of 19%, compared to the S&P 500's average 9% rise."

RBC Capital analyst Gerard Cassidy is more explicit. "Should President Obama not be re-elected, the banking sector, one of the most vilified industries in Washington, D.C., would likely see its stock prices positively impacted by his loss."

--Written by Shanthi Bharatwaj in New York

>To contact the writer of this article, click here: Shanthi Bharatwaj.

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