Thursday, January 7, 2010

Banking on 2010 Credit Suisse

Banking on 2010
For 2010 we see US financials overall as still cheap, and our main changes vs. 2009 are becoming more constructive on banks (we recently upgraded regional banks to Overweight and we are upgrading the largest bank today, BAC, from Neutral to Outperform), and warming up on commercial lines P&C stocks, where fundamentals are poor, but we think the stocks are oversold. We remain constructive on the brokers, as indicated by our recent upgrade of MS, while we are moderately positive on life insurers, where valuations are still cheap but EPS visibility will be constrained if interest rates remain at current levels. We are less positive/more cautious on credit card companies, asset managers and trust banks, where valuations are less attractive, and which we would consider using as a source of funds to put money to work within financials. Our more constructive stance on the banks is not without some hesitation, owed to the all-time high of government involvement, which makes assessing the “cheapness” of stocks more difficult. Having said that, the fear and risk of severe “too big to fail” capital rules will diminish if time continues to pass and no new legislation gets enacted. The key catalyst for the banks will be the end of loan loss reserve builds, and the eventual release of a portion of those reserves, which we project will be a big driver of EPS growth in 2011/2012.

Our “warming up” stance of the commercial lines P&C insurers is perhaps the least intuitive and the most non-consensus view within our financials outlook. Having said that, P&C represents the only area within financials where the stocks are still trading below historical lows, and where there has been no material structural change in required capital and no permanent ROE degradation in the wake of the financial crises.

On the life insurance sector, we retain a moderately positive stance on the sector despite the fact that fundamentals are uninspiring, as we think most companies will struggle to produce ROE’s much above 10% if interest rates remain depressed. In this regard, our top ideas of AFL and PRU (hence our “Duck and a Rock” Outlook Title) should both have above average EPS resiliency if interest rates do remain depressed, and we also see capital deployment/capital builds as a 2H 2010 catalyst for both stocks.

For those companies leveraged to the capital markets (brokers and advisory firms, discount retail brokers, trust banks and financial exchanges), we are generally constructive on revenue, earnings and return prospects. We believe important themes will emerge including regulation (with particular focus on capital/leverage standards and derivatives reform), post financial crisis workout efforts (i.e., beginning of quantitative easing extraction, the impact of rising interest rates), consolidation of recent market share gains, opportunities for more active capital management.

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