U.S. Mid- and Small-Cap Banks JP-MORGAN $FITB $STI

Although the speed of credit recovery could likely follow in the footsteps of a slower than expected pace of economic recovery, we look for 2Q trends to provide sufficient evidence that credit quality for the banks is indeed in recovery mode. However, as the road to credit recovery becomes clearer, we see the focus on normalized earnings expanding to include more emphasis on normalized P/E. Although the sector valuation improving from the current 9.5x normalized EPS to the historical 14.0x multiple implies strong upside over time, to realize this potential, we believe the markets must see the outlook for bottom line organic growth beyond what will come from credit and rate normalization improving to at least the 8% to 10% range. Given that it’s unlikely this evidence is provided over the near-term, at this juncture we would concentrate larger positions on the consolidators in the group, viewed as the sub-set of banks in the group that have the most potential to move the earnings needle upward in a sluggish economy. We would own a smaller portfolio of bank stocks with strong organic growth potential and even less in credit only types of names.