Will 2013 Be a Boon for Banks?

“We have great earnings power,” Brian Moynihan told CNBC’s Maria Bartiromo at January’s World Economic Forum in Davos, Switzerland, explaining why Bank of America’s (NYSE:BAC) stock was up over 100 percent in 2012.

It’s an opinion shared by Guggenheim Securities analyst Marty Mosby, who believes that both Bank of America and Citigroup (NYSE:C) “represent more than 30% upside potential” this year. A research note seen by TheStreet expounds on his expectations for the two banks. For Bank of America, Mosby forecast a return on tangible common equity (ROTCE) of 8.1 percent, with a cost of equity of 12.9 percent. He expects a ROTCE of 8.8 percent for Citigroup, setting its cost of equity at 13.2 percent.

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Bank of America and Citigroup are the only two large-capitalization banks covered by Guggenheim that are still trading below tangible book value, meaning their stocks are underpriced. Book value refers to a company’s total assets minus its liabilities. Mosby has a “buy” rating on both companies and expects them to trade above their book values by the end of the year. On Tuesday he lifted his price target on shares of Bank of America to $15 from $14, and raised his target for Citigroup to $57 from $55…
Both banks have increased their capital reserves in preparation for this year’s stress tests. Banking regulators began the annual stress test process back in 2009, during the depths of the financial crisis, and they have become a key method for the Federal Reserve to supervise the health of financial institutions in the United States.

“The aim of the annual reviews is to ensure that large, complex banking institutions have robust, forward-looking capital planning processes that account for their unique risks, and to help ensure that institutions have sufficient capital to continue operations throughout times of economic and financial stress,” wrote the Fed in a November press release.

Of all its big banking rivals, Bank of America has the highest capital ratios; at the end of 2012, its Basel III capital level was an estimated 9.25 percent, up 130 basis points from the previous year and above the required 8.5 percent. For Citigroup, its capital levels increased last year as well, with its Basel III ratio at an estimated 8.7 percent
According to Mosby, the increases in capital levels will have a positive effect on both companies’ stock prices if the excess capital is used for shareholder dividends after the tests are completed in March. He predicts that Bank of America will increase its payout by 20 cents per share, while Citigroup’s will be lifted to $1.00. Currently, both institutions pay a nominal quarterly dividend of 1 cent per share. Mosby’s estimate was based on the assumption that “it is in management’s best interest to use all of their excess capital to increase their dividends instead of repurchasing shares,” he wrote.

But Oppenheimer analyst Chris Kotowski disagreed. He told investors on Monday to have “guarded expectations” for dividend increases after the stress tests. While he noted in a research note seen by TheStreet that both banks “have high and rising capital ratios,” Kotowski cautioned that “industry’s recent history suggests that the banks get let out of the penalty box only very slowly.”

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