Inside Wall Street: The Case for Buying Bank Shares Now

Gene Marcial's Inside Wall StreetThe congressional wrangling is over, and what's been billed as the most sweeping financial overhaul since the Great Depression is finally ready for the full House and Senate to vote on it. Assuming all goes according to plan and President Obama signs the bill into law by July 4, what happens then?

Some investment pros are aiming straight at the eye of the financial hurricane, buying into the besieged banks. Here's why: The uncertainty and dark clouds threatening the financials have dissipated, and banks will now have to tread on new ground with new rules, and start exploring ways to profit from them.

To the surprise of many, Wall Street was greatly relieved on Friday after the long-awaited reform bill got hammered out overnight before the market opened. "It could have been a lot worse," exclaims Matthew Albrecht, banking industry analyst at Standard & Poor's. As it turns out, the massive overhaul is "less onerous than what we had expected -- and what it could have been," he says. Overall, it's a "favorable development" for the industry.

Time to Adjust

Some of the bill's worst-feared elements among banking interests came out not as bad as, well, feared. The compromise on the Volcker rule, for instance, isn't as forbidding for the banks, says Albrecht. It will still allow them to invest up to 3% of their capital in hedge funds, instead of being entirely barred from them.

And the banks can also deal with the new rules on the controversial derivatives trading, he adds. The bill gives them two years to move such operations to separately capitalized subsidiaries. The objective is to create more transparency to curb conflicts of interest. Certain derivatives trading, such as interest rate swaps, would also be allowed if they're done to hedge the banks' own risks.

So, Albrecht is keeping his strong buy recommendation on banking industry leaders JPMorgan Chase (JPM) and Bank of America (BAC). He believes they're best equipped to cope with and profit from the current economic environment and the financial overhaul, given their vast assets, capital resources and diversified markets.

Albrecht also reiterated his buy rating on Citigroup (C), Bank of New York Mellon and Wells Fargo (WFC).

Still "Too Many Unknowns"?

However, the S&P analyst is staying forthright with his sell recommendation on No.1 investment bank Goldman Sachs (GS). The company, he explains, has the extra burden of having to grapple with another can of worms -- its problems with the Securities and Exchange Commission and the Justice Dept. over allegations of fraud. The damages and fines that could shoot up from the SEC's accusation, and collateral damages from various other lawsuits have yet to be quantified and won't be determined anytime soon, says Albrecht.

However, some investment managers who avoided the banks way before the passage of the reform bill are still wary. "We are extremely underweight the banks and plan to stay that way," says Richard Steinberg, president of the Steinberg Global Capital Management. For the large money-center banks with global operations, "there are too many unknowns with -- real estate, sovereign debt and the threat of a weakening global economy," says Steinberg.

But Richard Bove, banking analyst at Rochdale Securities, insists that the banks are now among the best investment plays. The reform bill, he points out, won't do much damage to them, and he rates the banks a buy as the compromise regulatory bill cleared the air on many issues confronting the industry.

In an interview with Bloomberg TV, Bove pointed out that contrary to the Street's expectations, concerns over the reform bill turned out to be highly exaggerated. So, he reiterated his buy rating on the major banks, including JPMorgan, BofA, Citigroup and PNC Financial Services (PNC).

Revised Estimates

Indeed, banking stocks displayed unusual energy on Friday, and helped lift the S&P 500-stock index and the Nasdaq. The Dow Jones industrial average, after showing strength early in the day, closed a tad lower. The market had been on a four-day losing streak before Friday's spirited session.

"Regulatory reform will certainly reduce industry profitability, but we think revenues and profits will continue to grow," says S&P's Albrecht. He has adjusted his earnings forecasts for JPMorgan to account not only for the reform bill but to also to reflect continuing weakness in the housing market, volatile stock prices and the extended period of low interest rates.

Albrecht trimmed his earnings projections for JPMorgan, by 20 cents a share to $3, and his 2011 estimate by 14 cents to $4.08. JPMorgan earned $2.24 a share in 2009. He also scaled back his 12-month price target for Morgan's stock by $9 a share, to $48. Three years ago, the stock had soared to a high of $53.

At BofA, Albrecht expects revenues to grow by 6% in each of the next two years, although he figures banking and credit card fees could get trimmed by the new regulations. Moreover, he sees mortgage banking fees declining, as volume shrinks. However, he expects the results from the momentum of strong trading and investment banking to persist, especially when the economic recovery gathers more steam. Also a plus is the continuing decline in loan-loss provisions, which the analyst expects over the next two years as delinquencies across most asset categories have stabilized or dropped.

Likely to Bounce Around

He notes that unemployment is still at high levels, and the economy is only starting to recover. But the worst of the charge-offs have probably passed, says Albrecht. He also expects BofA's operating expenses to decline in 2010 and 2011 as "efficiencies from acquisitions (including the Merrill Lynch purchase) and operating leverage are realized." He figures BofA will earn $1.19 a share in 2010 and $1.92 in 2011. His 12-month target for the stock, which climbed 40 cents a share, or 2.66%, to $15.42 on Friday, is $26 a share. It traded as high as $45 in 2008.

No doubt, the financial stocks will continue to bounce around for a while as investors struggle to understand all the rule changes -- and update their portfolios accordingly. One thing to keep in mind: The banking sector has already discounted in large measure the impact of the financial-reform measure as it didn't participate much in the market's robust rally early this year. So it might prove opportunistic and rewarding to bank on the group this time.
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