As we discussed in our December Thesis Update, 2011 was a terrible year for the banks from a market perspective, as the sector both declined and underperformed the S&P (which was flat) by 25%. From an absolute return perspective, it was the 6th worst year since 1937 (Source: Barclays). From a relative perspective (i.e., versus the S&P 500), it was the 5th worst in 75 years. However, this month, the FDIC posted its aggregate Q4 data, and it is interesting to note how last year’s stock price performance was so divorced from the actual operating results for the full year.

Of note:

6.5%+ yield

Earnings growth was substantial. Large-cap banks (BKX) experienced reported earnings growth of ~30%, while core earnings growth was ~20% and now nearly “normal”. Mid-cap banks (KRX) saw earnings rise by ~46% Y/Y. Using the much followed FDIC data for regulated bank subsidiaries-only (public, private, foreign platforms, but excluding non-bank businesses like broker-dealers), sector earnings increased by $34 bln in 2011 versus 2010. Pre-tax pre-provision earnings (“PTPPE”) was down in the face of large declines in fixed income and equity trading at the largest banks. That said, the ~$190 bln in PTPPE generated in 2011 was still 18% higher than 2006 – the last “normal” year (i.e., $160 bln).  

Second, credit quality improved at a near record rate. In 2011, the net charge-off (NCO) ratio declined by 106 bps, the largest annual decline since 1937. It was also more than double the decline in 1993 (↓ 42 bps), which was the second largest decline since the ‘30’s, and ended a three year period of bank outperformance totaling 50%. Moreover, the quarterly run-rate charge-offs declined nearly 50% (i.e., Q4-10 vs. Q4-11). NPAs, or “bad loans”, declined $30 bln on the year, while NPLs declined by $24 bln (12% and 10%, respectively).

Lastly, balance sheets continue to be very strong. Tangible common equity rose by  $55 bln, or 8%, to $781 bln, or double the 2008 trough. Reserves, which had quadrupled during the downturn, began to decline (tracking the substantial declines in NCOs), but they still remain about 2.5x higher than the pre-cycle rate/level.

Sources: Barclays, Bloomberg, FDIC, HCP

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