As bad-loan provisions at European banks start getting smaller, some analysts are betting that banks with strong retail franchises will benefit the most and lead the next stage of a continuing rally in financial stocks.
That is at odds with the prevailing wisdom that banks specializing in commercial and investment banking are in better shape to keep beating earnings forecasts because of strong volumes this year in businesses including bond sales and currency trading.
"We think the real driver of earnings upgrades in the medium term will be the provision line — which argues for an overweight retail stance," Derek De Vries, an analyst at Bank of America Merrill Lynch, wrote in a research note Tuesday, naming institutions such as Danske Bank A/S, Nordea Bank AB and Skandinaviska Enskilda Banken AB as big beneficiaries of lower provisions.
Bolstering his argument is the likelihood of stricter regulation for investment banks that would require them to hold more capital, and the assumption that a lot of good news is already priced into wholesale bank shares.
JPMorgan Chase & Co. analysts made a similar judgment in September, and Monday they highlighted HSBC Holdings PLC, UniCredit SpA, Societe Generale SA and Banco Bilbao Vizcaya Argentaria SA as among those with potential for earnings upgrades in the next 18 months, if loan losses come in below expectations.
"We expect P&L dynamics to improve significantly for traditional credit banks, as loan losses start to improve sharply from 2011 at the latest, more than offsetting any margin pressure on revenues," these analysts said.