There were at least a couple reasons why this should not have been an especially good year for banks in the United States. Low interest rates have made it very difficult for banks to thrive on their core spread businesses, and new banking regulations have certainly crimped their ability to generate the same fee-based income as before. And yet, lending has gradually improved and many banks have seen investors increasingly become willing to assign more reasonable valuations to their shares.

All in all, the regional banking industry has seen better than an approximate 30% appreciation this year, well ahead of the 13% gain in the S&P 500.

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Big Winners Include Some Big Prior Losers
To a certain extent, the strong performance in the banking industry this year is a reaction to the very poor performance of prior years and the cellar-dwelling valuations that resulted.

Some of the top performers this year were some of the biggest laggards of the post-housing crash banking world. While not really a regional bank per se, Bank of America (NYSE:BAC) has nevertheless been one of the strongest performers as these shares have gone up nearly 99% so far in 2012. Bank of America is still a long way from being a thriving retail bank again, but the company has made progress in fixing its sizable mortgage repurchase problems.

Likewise, the much smaller Synovus (NYSE:SNV) has managed to restore some faith in its ability to continue on as a going concern. While Synovus has been crushed by bad debts and the sharp decline in the banking business in the state of Georgia, the company does seem to be getting better. Shares are up nearly 65% so far this year, and the company recently announced the sale of a large amount of the distressed assets on its books. With this move, and slowly improving operating conditions, management has stated that it believes TARP repayment is a possibility in the first half of 2013.

SEE: Bank Of America's Return To Profitability

Back to the Business of Business
It is not just the banks that got battered the worst that have seen market-beating performance this year. Solid names like U.S. Bancorp (NYSE:USB), Wells Fargo (NYSE:WFC) and BB&T (NYSE:BBT) have also delivered market-beating returns so far in 2012.

While there are of course important differences between these banks, there are also some meaningful similarities. All of these companies are known for having strong retail branch banking franchises, and each of these companies have continued to execute in their core markets. Wells Fargo remains a share leader in mortgage banking, while U.S. Bancorp has continued to drive strong results from its non-banking operations like merchant services and corporate treasury. For BB&T, the company has seen solid commercial loan performance and has managed to take advantage of the banking crisis by acquiring several quality businesses throughout the South.

The Bottom Line
It's worth noting that this year's outperformance in the banking sector is really not a byproduct of remarkable revenue or earnings growth. In many cases, pre-provision net revenue growth has been on the order of single digits, and many banks have had to work hard to make progress in cutting their operating expenses. Instead, a meaningful portion of the outperformance for many bank stocks has stemmed from the expansion of valuation multiples, as investors have gone from valuing these companies at historically below-average multiples to more normal levels.

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Investors would do well to be cautious (if cautiously optimistic) regarding this sector in 2013. The Fed's decision to maintain very low interest rates will make it very difficult for companies to earn robust net interest spreads. Likewise, worries tied to the fiscal cliff could impair loan growth for at least the first half of the year. All of that said, difficult industry conditions are often the times when the quality franchises show that quality and widen their lead on lesser competitors, so while 2013 may be a difficult year in general, investors holding quality bank stocks should be in no great hurry to sell.

At the time of writing, Stephen D. Simpson owned shares of BB&T for more than five years.



Tickers in this Article: BAC, SNV, USB, WFC

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