Bank on bank stocks – but not on their survival

More banks are expected to fail by the end of the year, but analysts still expect their stocks to continue to gain value.

A total of 67 banks failed year-to-date through Aug. 7, nearly three times the 25 closings for all of 2008, according to the Federal Deposit Insurance Corp.

But that could just be the tip of the iceberg for 2009, according to one expert.

“I estimate 150 to 200 banks will fail by the end of the year,” said Richard Bove, bank analyst with Rochdale Securities LLC of Stamford, Conn.

Many of the banks that failed this year were smaller community banks, and their biggest challenge was residential-real-estate loans, he said.

“Most of the small banks collect deposits and make loans on residential real estate,” Mr. Bove said. “That industry is in trouble, so they are in trouble.”

But though additional banks may not make it through the financial crisis, things are looking up for investors in bank stocks in general, Mr. Bove said.

BRIGHTER DAYS AHEAD

“The economy may be on the cusp of a turnaround, and the problems that banks have faced may be declining,” he said. “I expect that bank stocks will do quite well for the next couple of years.”

Indeed, bank stocks have experienced a rally in recent months.

Consider the stock price of Charlotte, N.C.-based Bank of America Corp., which closed at $16.42 Aug. 7, up from its year-to-date low of $3.14 March 6.

Also, the stock of regional Fifth Third Bancorp of Cincinnati closed at $9.71 Aug. 7, up from its year-to-date low of $1.03 Feb. 20, according to data compiled by Chicago-based fund tracker Morningstar Inc.

“We’ve seen such a turnaround rally in bank stocks in the past month alone. It’s almost a tale of two cities,” said Harry Milling, mutual fund analyst at Morningstar.

Banks are being valued more reasonably now, Mr. Bove said.

Last year, bank stocks were valued based on what they would be worth upon liquidation, and now they are being valued based on what they would be in a normal market, he added.

“That’s a reflection of going from panic to a reasonable and rational view of what’s going on,” Mr. Bove said.

UNDERVALUED?

Other analysts agree that bank stocks are being valued with a view toward economic recovery and anticipated future earnings.

“People are seeing that the economy is no longer declining precipitously,” said James Sinegal, bank stock analyst at Morningstar.

“We think, in general, a lot of the banks are still moderately undervalued,” he said. “There is still some upside potential.”

Investors looking to participate in the rally — but wanting diversification — may gravitate to financial-sector mutual funds.

These funds, which include an average of about 30% of their holdings in banks, also invest in the stocks of other financial services firms, such as insurance companies, investment banks and asset managers.

The 41 financial-sector funds tracked by Morningstar had an average return of 20.73% year-to-date through Aug. 7., which outpaced the Standard & Poor’s 500 stock index’s return of 13.61% for the same time period.

In the trailing-one-month period alone through Aug. 7, the funds posted an average return of 21.75%, outperforming the S&P 500’s 14.89%.

E-mail Sue Asci at [email protected].