Barrons: Morgan Keegan on Banks

Barrons published yesterday in their Soapbox section a Morgan Keegan article regarding the banking sector.  Excerpts, with my highlights:

VALUATIONS FOLLOWING THE recent rally in bank stocks are now factoring in a faster than previously expected improvement in credit quality and a return to normalized earnings on an accelerated time table. This view has been supported in recent weeks by the reaffirmation for a return to sustainable profitability in 2010 by several bank managements. As a result, the bar for first-quarter 2010 results has been set high and any disappointment on the rate of credit improvement could cause a near-term pull back.

While odds have increased for a near-term pullback after the spectacular rally in the banks (KBW Bank Index up 20% year to date), the trend has been the investor's friend, and "it's a bull market until it's not". Today, there is an increasing sentiment to trim positions and book some profits in banks that have significantly outperformed.

While we can't argue against taking some profits here and that it may be the right strategy in the short term, but we believe that the longer-term risk-reward opportunity in the group still remains attractive and we would use any pullback to build positions. Credit losses appear to have peaked with many banks guiding for improving problem-loan inflows and loss severities which coupled with an improving secondary loan-sale market for problem-loan sales should help push the aggregate amount of problem assets lower through 2010. It also appears that investors will soon get clarity on regulatory changes and capital levels as some form of a negotiated regulatory-financial reform is passed by the Congress.

The Morgan Keegan Bank universe currently trades at 10.1 times normalized earnings-per-share .....We believe improving macro-economic and credit data coupled with reduced-dilution risk should continue to support the transition toward investors valuing banks on a normalized-earnings basis as we move closer to 2011. Given our view that longer term the group is likely to trade near the 12 times price-to-earnings range, we see further valuation upside implying that bank stocks should be trading higher a year from now.....

....We believe that the Federal Deposit Insurance Corporation (FDIC) recognizes the need to move away from the loss-share arrangements, which have made assisted transactions far more attractive to potential buyers, essentially putting a halt on non-FDIC merger and acquisition activity. As one bank chief executive put it: "Why would you buy a troubled bank in the open market if you know you can get it with a loss guarantee from the FDIC at a later date?"

A change in this mentality would allow the significant amount of capital that is currently sitting on the sidelines (healthy banks, special purpose-acquisition companies, private equity) to come in more freely to acquire and rescue troubled banks allowing these institutions to avoid a potential failure while letting the FDIC avoid taking over broken franchises, absorbing losses and giving loss-share economics to the buyer....As the economics even-out, credit and the economy improve, this should accelerate bidding for problem banks.

--Robert Patten

--Ebrahim Poonawala

--Gregory Welliver

Link:  Morgan Keegan on Banks

*Long ETFs related to bank stocks in client and personal accounts.