Why Bank Stocks Are Set to Soar

Bank stocks are primed to soar after five of the nation's largest banks finalized an agreement to settle federal and state probes into allegations of foreclosure abuse. The agreement is said to be worth as much as $26 billion and will remove at least one cloud of uncertainty that has depressed bank stocks over the last few years.

Assuming the deal is consummated, it will bring an end to discussions that have plagued the banking sector and the housing market since an employee at bank Ally Financial admitted in a June 2010 sworn deposition that he had signed hundreds of foreclosure documents daily without reviewing them as required.

In response, Ally suspended certain foreclosure sales and evictions in September 2010, a move that was emulated soon thereafter by banking giants JPMorgan Chase (NYS: JPM) and Bank of America (NYS: BAC) , among others.

According to the Wall Street Journal, the agreement includes $5 billion in cash penalties that the banks must pay to borrowers, states and the federal government. It also includes $1.5 billion in cash payments that the banks must make to borrowers who went through foreclosure between September 2008 and December 2011. And in addition to the aforementioned banks, the other private signatories to the deal were Citigroup (NYS: C) and Wells Fargo (NYS: WFC) .

While these payments will hardly make a dent in the problems depressing the housing market -- aggregate real estate values have been slashed by approximately $7 trillion since the housing bubble crashed, leaving 11 million homeowners underwater to the tune of $750 billion -- it represents a huge step forward for the financial sector -- not to mention that this is the largest government-industry settlement since the multistate deal with the tobacco industry in 1998.

But what giveth may also taketh away
At approximately the same time as news of the above agreement came to light, it was reported that the Securities and Exchange Commission plans to warn several major banks of impending lawsuits related to the securitization of mortgages.

While it isn't clear which banks will receive the formal notices, known as "Wells notices," the banks whose activities are being examined include those mentioned above, as well as Deutsche Bank and Goldman Sachs.

The move could mark a continuation of the SEC's stepped up efforts to hold financial institutions accountable for losses associated with the financial crisis. Among others, Swiss banking giant UBS (NYS: UBS) acknowledged that the agency is investigating its 2007 valuation, structuring, and underwriting of collateralized debt obligations.

While it's too early to speculate about the impact that the latter suit will have on bank shares, suffice it to say that the resolution of the preceding case is clear evidence that these companies are moving in the right direction.

So is it time to buy bank stocks?

Thus far this year, bank shareholders have been rewarded handsomely. As you can see in the table below, shares in the nation's four largest banks are all up by double digits since the beginning of 2012 alone.

Bank

YTD Performance

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Bank of America 47% Add
Citigroup 28% Add
JPMorgan Chase 14% Add
Wells Fargo 11% Add

Source: Finviz.com.

It was this market-topping performance that led our financial industry analyst Anand Chokkavelu to recently ask: Is Bank of America is back? In his discussion of its fourth quarter and full year 2011 earnings, Anand discussed the bank's improving Tier 1 common equity ratio -- an important metric related to a bank's solvency -- and its purportedly limited exposure to the bonds of troubled European governments like Greece, Portugal, Italy, and Ireland. Anand concluded that he's "bullish on Bank of America for advanced investors who can stomach the risk and unknowability of its balance sheet."

Moreover, in the most recent installment to his widely popular monthly series, Anand identified Citigroup as the 1 stock to buy in February. According to the column, "the combination of better management, the gutting of non-core assets, and the improving economy has put Citigroup in a much healthier position than it was a few years ago." Anand wrapped the column up by saying that, like Bank of America, he's "bullish on Citigroup as a risky global opportunity for 2012 and beyond."

Looking for other great recommendations?
If you want to get in on the banking sector's recent boon, but neither of these recommendations do it for you, check out our recently released free report on stocks only the smartest investors are buying. Among other revelations, it discloses the identity of a relatively small financial institution that Warren Buffett would have likely been attracted to in his younger years. To access this report while it's still available and before the rest of the market catches on, click here now -- it's free.

At the time this article was published Foolish contributing writer John Maxfield owns shares of Bank of America. The Motley Fool owns shares of JPMorgan Chase, Citigroup, Bank of America, and Wells Fargo. The Fool owns shares of and has created a covered strangle position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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