There was panic, there were stress tests, there were capital raises and bailout repayments. And after all of the drama, bank stocks ended the year pretty much where they started.

Nine months after shares of the nation's financial institutions plunged to fear-inducing lows, it is still remarkable to think how quickly it all turned, and perhaps all the more tricky to hazard a guess as to how the sector will perform in 2010.

There are no steep depths to climb out from, no great highs to come down from — just questions, same as when 2009 began, about when this credit cycle will be complete, and when banks will get back to earnings that can finally be identified as "normalized."

Whatever the answers, there is a lot more money riding on them now than before the year began. The industry sold tens of billions of dollars in equity in just a few short weeks following the May disclosure of government stress tests that showed the funding gaps that needed to be closed by the country's 19 largest financial institutions. Tens of billions more got raised in December by Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. as a condition of their exit from the Troubled Asset Relief Program.

It was not just a buildup of dry powder that steered investors into the stocks. The bulls are betting that the worst of the industry's credit issues already have been identified, that the bulk of the loan-loss provisioning has been done, that the jobs picture will gradually improve and that failures of the weakest banks will leave the rest of the industry stronger.

"While nobody is expecting rapid growth, the economy is on the mend, and the capital position of banks that look to be able to survive has improved dramatically," said Frederick Cannon, co-director of research and chief equity strategist at KBW Inc.'s Keefe, Bruyette & Woods Inc. "So the balance sheets are much stronger than they were a year ago, and the overall outlook is better."

There is still reason to be cautious, however.

The political backdrop for banks continues to look troublesome, the shakeout in commercial real estate is not over and the potential for stronger regulation and stricter capital standards remains — all of which could have a long-lasting impact on the industry's prospects for profitability. But the market does not appear to be terribly fixated on profits at the moment.

"The key ingredient for higher bank stock prices over the near term will have little to do with earnings and everything to do with visibility for the credit cycle turn and brighter days ahead," said Anthony Polini, an analyst with Raymond James & Associates.

Just in case, banks should have the benefit of a positive-sloping yield curve and favorable loan and deposit pricing to help offset the potential headwinds to earnings, he said.

Of course, what will pass for normalized earnings in banking is anyone's guess. But by at least some investors' definition of the term, bank stocks look relatively cheap.

According to Barclays Capital analyst Jason Goldberg, the perception that bank stocks are attractively priced has driven much of the interest in the sector this year. And as investors poured more money into bank stocks, banks looked all the healthier for it, allowing them to attract even more capital — a positive feedback loop in an industry that had become all too familiar with negative ones.

The KBW Bank Index more than doubled from its March low to finish 2009 at 42.71, down 3.6% from the end of 2008.

The ABA/Nasdaq bank index, skewed toward smaller-capitalization banks, finished the year 21.4% lower. The Nasdaq composite, in comparison, rose 43.9%, while the Standard & Poor's 500 Index finished up 23.5% for the year

On a price-to-expected-earnings basis, many bank stocks look to be trading at a relative discount to the broader market.

"If you believe the balance sheets have stabilized, and then you look at what we think these banks can earn as we evolve to a more normal environment, we think the big banks look pretty cheap," KBW's Cannon said.

Stock prices for the largest institutions are averaging about seven times normalized earnings, he said, an attractive ratio by historical standards.

Smaller banks look more expensive by that measure, with many trading at nine or 10 times normalized earnings, Cannon said, in part because failures have weeded out many of the weaker stocks from the indexes that track them.

With a sense that 2010 will be more about mopping up messes than panicking over them, many analysts predict bank stocks will have a smoother ride this year than in 2009.

"It was the most exhausting year we could all imagine in terms of the stocks, and we're basically back where we started," Cannon said.

"The good thing is at this level now, versus a year ago, I think we're looking up instead of down."

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