Time to stick a fork in the big banks?

June 21, 2011: 1:54 PM ET
Big banks like Goldman Sachs and Bank of America have dropped sharply this year.

Big bank stocks have plummeted this year. Click on the chart for a look at the performance of the KBW Bank Index.

NEW YORK (CNNMoney) -- I realize the next sentence will prompt many readers to thrust a finger above their shoulders in order to play a sad song on the world's smallest violin, but here goes: Bank stocks have been taken to the woodshed this year.

The KBW Bank Index (BKX) is down nearly 10% while the broader market is still clinging (albeit barely) to year-to-date gains.

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Several prominent bank stocks have done significantly worse.

Bank of America (BAC, Fortune 500) has plummeted 20% in 2011, making it the second-worst performer in the Dow. Citigroup (C, Fortune 500), despite a reverse stock split that finally enabled the bank to leave penny stock purgatory, has also fallen about 20%. Goldman Sachs (GS, Fortune 500) is also down about 20%.

Adding insult to injury, shares of Goldman are now trading only about 4% above the 52-week low it hit last summer when investors were nervous about the SEC's fraud charges against the investment bank. It's enough to make you wonder if vampire squids are an endangered species on Wall Street.

Many average Americans are probably reveling in the fact that the megabanks are struggling. After all, the banks were a big part of the financial meltdown in 2008 but wound up getting bailed out nonetheless. A healthy dose of schadenfreude is warranted.

So this next sentence will probably thrill readers still angry about TARP: There's a case to be made that big banks should continue to underperform the market for a while.

The fundamentals for the banking sector remain lousy. According to data from earnings tracker Factset, revenues for financials (which also includes insurers) are expected to be up just 3.8% in the second quarter. Of the market's 10 sectors, that's the one with the lowest growth rate.

But financials are expected to have the third-highest earnings growth rate in the second quarter. That implies that banks are relying on cost-cutting, and not actual demand, to juice profits.

Europe's sickly banks

Big banks may be able to benefit from the recent boom in mergers and initial public offerings. But after investment banking, other subsets of the banking business are on shaky ground.

With the economy once again slowing down, mortgage and credit card portfolios could take a hit. Banks may not go through another version of 2008, but it's not if consumer credit quality is pristine.

"We're underweight the financial sector. The foreclosure problem is still prevalent," said Maury Fertig, co-founder of Relative Value Partners, an investment advisory firm in Northbrook, Ill.

Legal and regulatory risks abound The lawsuit filed by The National Credit Union Administration against JPMorgan Chase (JPM, Fortune 500) and Royal Bank of Scotland (RBS) over mortgage-backed bond sales is the latest legal black eye for the banking industry.

The credit union regulator is alleging that the banks misrepresented the value of the securities, and that this led to the failure of five credit unions. This is unlikely to be the last lawsuit against large banks.

In addition to regulators, state attorneys general and federal and local prosecutors are all looking to make banks pay for the sins of the housing crisis.

While it's doubtful that any big bank will wind up paying through the nose for its legal battles (witness the relatively small sum of $154 million that JPMorgan agreed to pay Tuesday to settle charges over another mortgage investment ), why would any investor willingly want to buy stocks in an industry that faces the potential for even more litigation?

Lawmakers in Washington are also still trying to figure out how to best enforce the new rules for the industry that were written into the Dodd-Frank financial reform bill. So if you're banking (pardon on the pun) on Congress and lawyers to stop harassing financials, good luck with that.

"We are still dealing with an uncertain regulatory environment. There is a plethora of legislation to be written about implementing Dodd-Frank, and that is overshadowing everything else," said Frank Barkocy, director of research with Mendon Capital Advisors, a New York money manager that invests primarily in financial stocks.

What's on the balance sheet again? I talk to a lot of smart fund managers who say that even now, four years after the subprime mortgage crisis began to hurt banks in earnest, they have no clue what banks hold on their balance sheets.

There is a general sense that the assets held by banks are no longer toxic, but if it's still largely a guessing game for the pros, why should the average investor hold their nose and hope for the best?

"The only good news for banks is that sentiment is so negative. So there may be an opportunity for a bounce," said Keith Springer, president of Springer Financial Advisors in Sacramento, Calif. "But the news is still bad. I don't see a lot of compelling reason to invest in them."

That's not to say that all banks should be avoided like the plague. Some smaller lenders that didn't get into as much trouble during the past few years might be good bets right now.

Barkocy mentions People's United Financial (PBCT), a Connecticut lender that declined TARP funds, as one he likes. He also recommends F.N.B. (FNB), a bank based in Western Pennsylvania that could benefit from natural gas drilling in the Marcellus Shale.

And if consolidation continues to heat up in the banking sector, that bodes well for regional banks -- stock prices could go up on speculation.

Late last year, Bank of Montreal (BMO) agreed to buy Marshall & Ilsley (MI). Last week, Capital One (COF, Fortune 500) said it was buying the U.S. online banking assets of Dutch financial firm ING (ING). And on Monday, PNC (PNC, Fortune 500) announced it was purchasing the U.S. banking operations of Royal Bank of Canada (RY).

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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