Troubled banks delivered the best shareholder returns in the past year, but investors say the top performers in 2011 may be healthy institutions that can raise dividends and make acquisitions.
The current economic forecast — a slow rebound with no substantial loan growth or interest rate increases on the horizon — favors strong banks that had the weakest stock market gains in the past 12 months, investors say.
Examples include People's United Financial Inc., JPMorgan Chase & Co., First Niagara Financial Group Inc. and BB&T Corp. All have the strength to raise dividends or make big acquisitions. Those two things are likely to drive share prices now that credit quality is fading as the top investor concern, experts say. A spate of year-end dividend increases and mergers may also be a sign of things to come.
"It was really a year in which credit ended up not being as bad as some people had feared. Some banks with credit risk did better," said Charles Bobrinskoy, vice chairman, director of research and co-portfolio manager of Ariel Investments LLC in Chicago. "This year I'm predicting that quality [banks are] going to have a better year, and that is not what happened in 2010."
It was a good year for investors in banks with big problems when the year began, and fewer as it ended. The top-performing institution in Keefe, Bruyette & Woods Inc.'s KBW Bank Index was Zions Bancorp. in Salt Lake City. As of Monday, the company had returned 95% to investors in the past 12 months as it shed bad loans and moved closer to profitability, based on Bloomberg News data. No. 2 with returns of 94% was Huntington Bancshares Inc. of Columbus, Ohio, which ended a long period of losses in 2010 as it moved past problems with subprime loans.
Other strong performers included Citigroup Inc. and KeyCorp, which also had turnaround gains.
The worst performers on the KBW Index were banks that were the soundest, financially. In last place was People's United, with negative returns of 11.7%. JPMorgan Chase gained 5.5%, First Niagara 6.3% and BB&T 9.2%.
Experts said those companies now have the best shot at delivering outsize returns given uncertainty ahead. Real estate values remain depressed and job growth is anemic, so opportunities to grow by making loans are scant. Historically low interest rates and cutthroat pricing means there's little money to be made even if banks manage to find good borrowers.
Banks that won praise from investors for not losing money are now going to have to impress them by continuing to make money, which will be difficult with regulatory costs and still-elevated credit expenses weighing on profits.
"There is not going to be much organic growth if banks keep on doing what they've been doing. One of the few, and one of the easiest ways to improve operating margins in an environment of relatively slow growth is through consolidation," said Tom Mitchell, a senior analyst at Miller Tabak & Co.
Mitchell favors institutions that have characteristics that could let them be a buyer or a seller. Those that have lots of capital, manageable loan issues and an attractive deposit franchise. And they must be big enough to be worth buying, but not so large that the deal becomes unfeasible.
BB&T is an example of what Mitchell called institutions with "two-way" deal potential, as are the community banks City National Corp. of Los Angeles and FirstMerit Corp. of Akron, Ohio. "We're calling this one the year of the deal," he said.
