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Merrill Sees Bank Stocks Nearing Their Bottom

U.S. large-cap regional banks' stocks now appear to be in "capitulation mode" and will likely trade below fair value in the near term as more dividend cuts and capital raises, high credit risk and an uncertain earnings outlook all weigh on their share prices, an analyst at Merrill Lynch said.

Analyst Edward Najarian said he does not expect credit metrics to recover until 2010 and forecast more dividend cuts and capital raises at banks, including Bank of America and Wachovia, in the second half of this year.

Najarian also slashed his earnings estimates by an average of 22 percent for 2008 and 19 percent for 2009.

He said the cuts were largely due to higher loan losses, as well as an increase in loan loss reserve building.

"Our higher credit loss outlook is driven by higher loss assumption in nearly all consumer and commercial loan categories ... we have especially increased our loss assumptions for residential construction loans and home equity,'' Najarian wrote in a note to clients.

The analyst expects the median net charge-off ratio of large regional banks to triple to 1.14 percent in 2008, while loan loss provision-to-loan ratio is expected to increase to 1.87 percent in 2008 from 0.57 percent a year ago.

Second-quarter earnings, among the large regional banks, is expected to be "especially weak'' compared with prior quarters, Najarian said, adding that Bank of America and Wachovia may miss second-quarter Wall Street estimates by the greatest percentage.

He said earnings in the second quarter will likely come in a median that is 18 percent below consensus estimates mainly due to much higher net credit losses, more loan loss reserve building, and a lack of one-time Visa related gains that helped most large banks in the first quarter.

More Dividend Cuts

The analyst expects dividend cuts or capital raising, or both, at Bank of America, Regions Financial , SunTrust Banks and Wachovia in the second half of the year.

He said any of those moves would push the shares lower.

Dividend cuts or capital raises at banks are likely to significantly dilute existing shareholders, as banks raising capital will now have to do so at much lower stock prices than if they had during the first quarter, the analyst said.

In addition, the market's recent reaction to convertible and common equity issuances has been to heavily discount stock prices resulting in greater shareholder dilution, he added.

"We note that Bank of America, Regions Financial and Wachovia have already raised capital since the first quarter, and we think future attempts to raise additional capital will likely result in further downward pressure on the stocks,'' Najarian said.

Shares of Bank of America were down about 4 percent to $27.15, while Wachovia shares fell 4.5 percent to $16.96 in Friday morning trade on the New York Stock Exchange.

Regions Financial was down 5 percent at $10.62, SunTrust down about 6 percent at $33.29, KeyCorp down 2 percent at $11.17 and BB&T down 1 percent at $24.20.

The KBW Bank Index was down nearly 3 percent.

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BBT
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STI
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