Banking company profits are expected to grow more slowly this year than last year, but investors are still loading up on bank stocks.
Observers cite rising dividends, the broad migration of investors from large-cap to small-cap stocks (which has continued the small-bank rally), and the fact that many banking companies are buying back their own shares. Also, credit quality, which observers said investors fear more than anything else, is holding up well.
BB&T Corp. of Winston-Salem, N.C., has pledged to repurchase 12 to 14 million of its shares this year. TD Banknorth Inc. bought 8.1 million of its shares over several weeks in January and February.
And the fact that many more companies are pursuing buybacks has "really helped bank stocks," Thomas B. Michaud, a vice chairman and the head of sales and trading at Keefe, Bruyette & Woods Inc., said in an interview last week.
Some observers say investors may also be shifting money from other industries into banking. Also, investors in high-flying brokerage stocks may be looking for somewhere to take their profits.
Optimism about the sector this year appears well founded. Last year bank stocks failed to outperform the broad market for the first time in six years, despite rallying after the third-quarter earnings reports. However, bank stocks are retaining their gains from the late-year rally.
So far this year the American Banker index of 225 bank stocks had risen 2.4% as of midday Friday, while the Standard & Poor's 500 has risen 2.7%. Large-cap bank stocks, however, are not faring as well; the American Banker index of top 50 banks has risen 1.9%.
Last year the top 50 index rose 0.7%, while the index of 225 banks fell 5% and the S&P 500 rose 3%.
This year bank indexes are on the rise despite tempered expectations for first-quarter earnings reports, from both large and small banking companies.
"We are in a period of decelerating earnings growth," Mr. Michaud said.
John Augustine, the chief strategist of Fifth Third Bancorp's asset management unit, agreed that slowing growth "will be the theme for the first quarter."
However, both Mr. Michaud and Mr. Augustine say investors are already looking beyond the immediate results. Investors' hope for a steeper yield curve this year or next year is one of the major drivers for the group, the two analysts said. A slightly steeper yield curve sparked a mini-rally among bank stocks last week.
"The biggest torpedo always swimming in the ocean is credit quality, and there is nothing on the horizon that lets us believe that there is a credit quality problem," Mr. Michaud said. "We are watching, but we haven't seen any evidence" of a material deterioration even in consumer credit, much less commercial loan quality.
Still, some companies have indicated they expect higher consumer credit losses this year, though overall credit quality is expected to be stable.
JPMorgan Chase & Co. reiterated its credit outlook for this year in its 10-K filing last week. The company said it expects losses to be "driven by a trend toward a more normal level of provisioning for credit losses in the wholesale businesses." While it expects lower consumer credit card chargeoffs in the first six months of the year, after a run on bankruptcy filings as a result of the law that took effect in October, it also said it expects delinquencies and chargeoffs to rise in the second half as a result of higher payment minimums.
But observers say investors may wait until they are presented with concrete evidence of losses.
One theme that puzzled many observers last year and has persisted: Small-cap bank stocks are outperforming large-cap ones.
Last year many observers said speculation about a wave of consolidation targeting small banking companies buoyed their shares. But that wave never materialized, so some analysts say the group could be ready for a selloff.
Small-cap stocks have done well this year, but Mr. Michaud said that performance has less to do with bank fundamentals or speculation about consolidation than with broader market trends. Investors have generally favored small-cap stocks over large-cap ones, he said.
Richard Bookbinder, a managing member of Bookbinder Capital Management LLC, a fund of funds, said last week that he believes small-cap and midcap stocks have some steam left.
However, Mr. Michaud recommends that investors buck the trend and buy big-bank stock. So does Mr. Augustine, who said he believes shares of JPMorgan Chase, Wells Fargo & Co., Wachovia Corp., and KeyCorp should do well.
John McDonald, an analyst with Banc of America Securities added his two cents in a research note issued Friday. "We expect universal bank stocks to outperform trust/brokers/regionals near-term," he wrote. JPMorgan Chase and Citigroup Inc. "have been left out of the recent run-up of financials related to the strong capital markets environment," that lifted brokers, but "look attractive relative to other bank stocks heading into first quarter earnings."
Mr. Augustine said he is recommending JPMorgan Chase. As of midday Friday that company's shares had risen 4.2% this year; Wachovia Corp., up 5.4%; and KeyCorp, up 11.3%.
The biggest gainer among the companies Keefe Bruyette covers is Whitney Holding Corp., which has recovered well from last year's hurricanes. The New Orleans company's shares have risen 25.8% this year. Shares of another company affected by the storm, Hancock Holding Co. of Gulfport, Miss., have risen 13%.
Puerto Rican bank stocks remain volatile as the list of companies on the island forced to restate earnings over accounting issues has grown. Last week Santander BanCorp of San Juan became the fifth Puerto Rican banking company since early last year to announce accounting problems. Since the announcement its stock has dropped 8.6%.
Other losers so far this year include Citi, whose stock has dropped almost 2.8%.
"You have a couple of banks where earnings growth has really stalled out," said Mr. Michaud, who mentioned Citi and Bank of America Corp. as examples. "They don't seem to have a lot of downside in them in the moment, but there is a lot of upside when the interest rate picture changes, and that is how I would describe the large-cap market."
Some strategists and investors now expect the Federal Reserve Board to continue raising rates for longer than originally expected. Mr. Bookbinder said he expects the Fed to raise its benchmark short-term rate, currently 4.5%, by 50 to 75 basis points. The Federal Open Market Committee's next monthly meeting is scheduled for March 28.
"To the extent that the market believes that the Fed is going to continue its rate-raising campaign beyond this year, the bank stocks can be vulnerable," Mr. Michaud said. "But I think most people still believe that at some point in time this year the Fed is going to be done."
Peter J. Winter, an analyst with Bank of Montreal's Harris Nesbitt Corp., remains bearish on the entire banking sector.
"It is surprising that bank stocks are holding up as well as they are," he said in an interview last week. Though credit quality is good, bankers will eventually have to beef up loan-loss reserves to provide for rainier days, he said.
Mr. Winter advised his customers to sell bank stocks in late 2004, before they fell, and still recommends that customers underweight the sector.
Swiss Reinsurance Corp.'s Fox-Pitt, Kelton Inc. echoed his bearish tone on the sector in a research note last week. "We recommend investors continue to underweight the U.S. bank sector relative to the overall market, due to a combination of full valuation, uncertainty about the direction of interest rates and the flat curve, and slowing earnings growth."
