The recovery in bank share prices since their March lows suggests the worst may be over for the industry. Most of the current bank stock rally, however, reflects the elimination of the former depression-scenario discount, not improving fundamentals.
Nonetheless, investors have shifted their valuation focus from tangible book values to core earnings. The shift may, however, be premature given unresolved holdings of toxic assets. That means investors may be unprepared for the potential re-emergence of adverse credit events. Banks must demonstrate sufficient earnings power to cover toxic-asset losses to satisfy investor concerns. Weak loan growth, depressed returns on equity and an uncertain regulatory environment will complicate that effort.