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5 Reasons Why Bank Stocks Have Not Bottomed

Monday, April 07, 2008 | 12:00 PM

in Credit | Earnings | Employment | Valuation

Merrill Lynch says that they (ML) are through the worst of the credit crisis.

RBC Capital Markets believes that whether that is the case or not, Bank stocks remain attractive. Here are RBC's 5 reasons why bank stocks have not reached the bottom:

5 Reasons Why Bank Stocks Have Not Bottomed

1) Bank Stock Valuations Are Still Excessive:
• Current stock valuations of the Top 50 banks relative to historical valuations, remain expensive -- even with the recent poor performance.

• The Top 50 banks' forward 12-month P/E ratio stands at 13.2x, which is roughly one standard deviation above the mean (25-year avg of 10.9x).

• During the trough of the last two bank stock bear markets, 1990-91 and 2000-01, P/E ratios for the top 50 banks declined to 5.7x and 10.1x, respectively.

2) Recessionary Forces Will Lead To Bigger Credit Quality Problems:
• In prior recessionary periods, credit problems typically followed as a result of the weakening economy. We believe the U.S. economy is currently facing recessionary pressures that will only worsen extending into 2009.

3) Exposure to Riskiest Loan Areas Remains Extreme:
• Construction, Commercial Real Estate (CRE) and leveraged loans have provided steady growth over the past few years. Commercial loans outstanding for the US banking industry grew 64% from 2004 to 2007 due to demand from the syndicated loan market, in our opinion. As the economy weakens further in 2008, the underlying fundamental strength in commercial real estate and industrial America will soften leading to higher defaults in poorly underwritten CRE and leveraged loans.

4) Loan Loss Reserves Are Too Low:
• Bank management teams will often claim loan loss reserve adequacy only to boost reserves in subsequent quarters. We have adopted the Eyles Test (ET) for loan loss reserve strength. Banks should build and maintain reserves that will ensure survival during the down leg of the credit cycle.

5) Credit Problems Are Not Likely To Peak Until 2009:
• Given our belief that CRE, construction and leveraged loan portfolios have significant room to weaken in 2008, we believe credit problems will not reach their peak until sometime 2009.

Nice work . . .

Source:
Commercial Banks - Has The Hurricane Passed Or Are We In The Eye Of The Storm?
Gerard Cassidy, Jake Civiello
RBC Capital Markets, APRIL 3, 2008