Stocks of large financial institutions plummeted following the U.S. credit rating downgrade and many people lamented that the recession had begun anew. Analysts point out, however, that while the economy is in peril, the dangers it faces are unlike those seen in the recession. Banks are much healthier now with regard to liquidity, their holdings and ability to meet demands, and although a recovery in major areas of the economy such as employment and the housing market are not in full swing, the world has been engaged in corrective action. Economists believe it may help that world economies don’t have as far to fall and that the learning curve followed during the last recession can provide a path to a quicker rebound. For more on this continue reading the following article from The Street.
Bank stock investors may be suffering from a sense of déjà vu with shares of Bank of America(BAC) and Citigroup(C) plummeting on Monday, bringing back memories of 2008.
However Goldman Sachs(GS) analysts noted in a report that bad as things are, this is not the 2008 crisis all over again.
“While the “2008 all over” comments have increased, we believe the situation is different – bank balance sheets have much higher liquidity, better funding mixes (almost no reliance on short term funding), improved capital and reserve levels and less exposure to leveraged losses. All of these should help reduce excess volatility near term,” the analysts noted.
Goldman believes that banks should still be able to meet their funding needs, although rating downgrades for major banks remains increasingly likely following the U.S. rating downgrade.
According to the analysts, the near-term outlook effect of the U.S. downgrade is minimal, as treasuries/agencies make up just 18% of bank securities books and there is no change to risk weightings, which is a positive.
Over the longer term, their outlook remains hazy. “Over the long-term, the impact on banks will be on a case-by-case basis, taking into account macro conditions and each bank’s financial strength vs. the knock-on effects from the downgrade,” the analysts said.
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Other brokerage houses have already taken stock of the weakening economy and lower interest rates and have begun to downgrade estimates.
Strategists at RBC Capital and BMO Capital downgraded financials as the lower interest rate environment added further challenges to bank profitability.
RBC Capital lowered its rating on financials to underweight. “Low interest rates and a challenging regulatory environment represent lingering risks to profitability. Meanwhile, the top line remains pressured by a soft labor market recovery while Europe’s financial problems have not gone away. Yet, these macro headwinds have not deterred the analyst community,” equity strategist Myles Zyblock said in a research note. “The bottom-up earnings growth forecast for 2012 is 34%, the highest across all 10 sectors.”
The brokerage house downgraded the sector along with materials, industrials and consumer discretionary as it took stock of recent market volatility and economic concerns.
RBC’s sector analysts also offered their offensive picks- leveraged to a rising market- and defensive picks- protection in a falling market.
Jon Arfstrom recommends U.S. Bancorp(USB) and Cullen/Frost Bankers(CFR) for those looking for defensive positions in the central banking space. The analyst considers U.S. Bancorp among “the “best managed large-cap banks” that should give investors a “good balance of safety and upside potential.”
Cullen Frost is a good stock for conservative investors, the analyst says, because it is a high quality commercial lender with solid underwriting standards.
For those still betting that the slowdown is only temporary, Arfstrom recommends Fifth Third Bancorp(FITB) as it is well positioned to take advantage of organic and M&A opportunities in a recovering economy.
Associated Bancorp(ASBC) is a solid turnaround story that should do well if the economy recovers because it has a multi-faceted growth engine. “The strengthening growth outlook is being driven by a stable Midwestern economy, a national lending expansion, the potential to benefit materially from dislocation in the Milwaukee market, and a Chicago expansion effort,” Arfstrom said. If the economy weakens, credit performance will likely be stable as the management purged the higher risk credits during bulk loan sales in 2010, the note said.
Analyst Jason Arnold named Discover Financial(DFS) and Capital One Financial(COF) as top offensive plays. Discover is the top name to own in cards, according to the analyst, while Capital One is worth a trade for those expecting a market bounce and are willing to take on a riskier story.
Good defensive picks could also be found in the REITs space, Arnold notes, with Annaly Capital(NLY) and American Capital Agency(AGNC) being favorites.
Meanwhile BMO Capital analysts Lana Chan and Peter Winter said in a note that the recent weakness in economic data and drop in interest rates were leading them to cut estimates once again. If the economy continues to stall and there is no growth in 2012, bank stocks have a potential upside of only 9% from current levels, by their calculations.
BMO’s top picks for a “no growth” scenario include U.S.Bancorp, Fifth Third and PNC Financial(PNC) among the regionals and East West Bancorp(EWBC), Cathay General Bancorp(CATY) and Prosperity Bancshares(PRSP).
This article was republished with permission from The Street.