Pay close attention to Walter Todd's comments, and one gets a sense of what's behind the shine investors have taken to bank stocks.
Todd, portfolio manager and co-chief investment officer at Greenwood Capital Associates LLC, has slowly rebuilt his position in financial stocks. Before the recession, Greenwood had about 30% of its $250 million equity portfolio in financial shares. Today, the proportion is about 7%, nearly double last year's 3.5% to 4%.
"The worst-case scenario has been taken off the table for a lot of these names," he said. "The earning environment for these companies, because of the yield curve, is very favorable. Their borrowing costs are essentially zero for all intents and purposes."
That last part. That is what sticks out. Did he say "favorable" earnings potential?
With investors suddenly bullish on banks' earnings prospects, financial companies raised nearly $50 billion in stock offerings last month to boost capital, more than one and a half times the amount they had raised in the year's first four months.
Observers cite several other reasons that investors are moving back into the sector after selling down their positions in the last year or so: the confidence instilled by the government's stress tests that the major banking companies would survive; affordable prices; and the desire of mutual funds, pension funds and others to dive back in since they had missed out on the bank rally that began in March.
Those are all sound rationales, but a guarded optimism also seems to have emerged about banking itself. Walter "Bucky" Hellwig, a senior vice president at the Morgan asset management unit of Regions Financial Corp., said investors are upbeat about banks' potential to earn money as they emerge from the recession, given the wide yield curve on 2-year and 10-year Treasury notes. It bodes well for banks' net interest margins when long-term notes have higher interest rates than those with shorter maturities because banks tend to make long-term loans with short-term funds, he said.
"They should be able to make money with the yield curve sloped the way it is," Hellwig said.
No one is saying the industry is out of the woods, however.
Richard Bove, a Rochdale Securities analyst, says more massive credit losses are still on the horizon for the nation's banks. But he agrees that the major banking companies have strong earnings potential as they emerge from the recession, thanks to historically low borrowing rates and other factors.
"It is now being conceded, by even the most bearish observers, that claims that the industry was insolvent were incorrect and, therefore, banking will survive and possibly thrive," he said in a research note late last week on Bank of America Corp.
The KBW Bank Index, which comprises 24 of the country's largest banking companies, has been steadily climbing since hitting a 52-week bottom of 17.75 on March 6. On Tuesday, it closed down 2.42%, at 36.73. Meanwhile, financial companies like Bank of America Corp. and PNC Financial Services Group Inc. went on a capital-raising spree last month in order to satisfy mandates from the government's stress tests. In all, financial companies raised $49.2 billion in May, with 62.1% of that amount going to eight of the largest banks, according to KBW Inc.'s Keefe, Bruyette & Woods Inc.
A number of the offerings last month and since then were issued at a discount to drum up interest.
William Fitzpatrick, an analyst at Optique Capital Management, has seen his firm broaden its exposure to financial stocks on renewed optimism about financial firms. His company, which manages $900 million of total assets, has about 18% of its equity portfolio in financial stocks, up from 15% six months ago. "We're slowly adding to our position," Fitzpatrick said. "We just think that a lot of the financials were oversold. There are several indicators that would suggest the credit crisis is easing."
Mark Fitzgibbon, head of research at Sandler O'Neill & Partners LP, said Fitzpatrick is not alone. Investors who sold off banking stocks throughout the recession are wading back in to financials, taking advantage of the wave of recent discounted offerings to reinvest in a sector that has been rebounding since March, he said.
"I think a lot of mutual funds, pension funds, hedge funds were underinvested in financial stocks," Fitzgibbon said. "There is a school of thought out there that they've missed the move in the stocks [in recent months] and they are participating in these deals as a way of getting exposure to the sector at some kind of discount."
Still, Hellwig's firm, which manages $30 billion, has remained neutral in its exposure to financial stocks. He said he expects banking shares to plateau after spiking rather sharply this spring.
"The one potential fly in the ointment is that these stocks may have run too far, too fast. And [investors] are just counting a lot of good news and, therefore, they may be at a temporary peak," he said.