Author: Andy Schornack
Covestor models: Financial Services, Market Maven
Disclosure: Long JPM
The market has recently pulled back from an impressive run thus far in 2012. The overall market has certainly been encouraging. The financial sector is not as cheap as it was in late 2011, but it still provides value going into an economic recovery.
As the constant whipping boy of Mr. Market, the financial sector has created more volatility than I would like but I cannot help look out three to five years and see the long-term returns these stocks will produce. The media does not like to characterize loan loss reserve reductions for what they are, better asset quality at financial institutions across the country. Banks continue to work through their troubled credit and reposition the balance sheet for long-term growth. The FDIC recently reported that FDIC-insured institutions earned $26.3 billion in the four quarter of 2011 and full-year net income of $119.5 billion, the highest level since 2006.
The long story for the financial sector is based on the outlook that we are in a recovery, loan loss reserves are adequate at many financial institutions, and rates on loans are likely to increase in 2014 the 2016 period. Given a lag in any corresponding increase in cost of deposits, net interest margins will increase and provide improved earnings. Now couple this with increased loan demand, and you will see very positive movement in earnings from financial institutions.
Higher earnings will then increase dividends, share buybacks, and merger and acquisition activity among regional and super regional banking institutions. The M&A activity is driven by the need to expand footprints and regulatory policies favoring larger institutions. Even in the community banking sector, I have heard much more discussion about acquisitions in 2012 than I have heard since the downturn.
The Covestor Financial Services Model has a mix of large financial institutions and regional banks that I believe are well positioned to take advantage of the changing landscape. The road may be bumpy but we are headed in a positive direction.
