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Banks Are Back !

JP Morgan started the earnings season with a big bang - it earned over $17 Billion in 2010 ($4.8 Billion in Q4 itself). This is just after 2 years when many of these banks were teetering on verge of vanishing or falling under government control. This bodes well for earnings due from other banks in next two weeks.

What are the catalysts for this earnings boost  which is expected to be over 30% compared to Q42009 across banking sector ? Here are my thoughts:

  • Say thanks to Ben for keeping interest rates at historically low rates for extended period. When banks can borrow below 1% and give loans anywhere between 4-10%, that's big spread giving major boost to earnings. This "golden" period would continue for another 2-3 quarters since Ben (Bernanke) has promised to keep rates low till unemployment shows significant progress (read below 8%)
  • Banks have become very picky when issuing loans or mortgages. The amount of documentations they are requesting during refinance has swung the pendulum to extra cautiousness. This is good in long-term since overall quality of loan book should improve significantly in years ahead
  • Banks have built huge loss-reserves during dark days of 2008 and 2009. However defaults are coming lower than expected and hence they would start reducing these loss-reserves over next few quarters boosting earnings
  • Overall pickup in economic growth bodes well for banks since more economic activity means more demand for loans putting capital at work
  • Fees, fees and fees - while new regulations are putting screws on what banks can charge, banks are always very "innovative" when it comes to charging fees within those regulations. I won't be surprised if banks start charging fees just to keep your money in banks 
So with so many catalysts to earnings boost, banks would start raising their dividends on common stock eventually reaching yield of about 2%. So as investors, one need to position for this rising tide. Here are my recommendations. There are just too many - so you can pick whatever fits your investing style:
  • Big banks - BAC ($15), C ($5) and JPM ($44), STD ($10.50)
  • US Regional banks - SNV ($2.7), HBAN ($7), RF ($7)
  • ETF: XLF ($16) or for most aggressive investors FAS ($29)
Most of these should return between 20-30% over next 18 months !

Have a great MLK weekend !

/Shyam

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