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Credit Outlook: Sector Updates and Top Bond Picks

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Banks
For both large U.S. banks and U.S regional banks, this last quarter was much more of the same from a balance sheet perspective. Nonperforming loans as a percentage of total loans continue to drop, tangible common equity continues to build, and the deposit base for most banks continues to grow. We expect this trend to continue for the next few quarters, with the only major caveat being a severe breakdown in fiscal cliff negotiations, which would likely lead to a recession in the U.S. The momentum of recovery for U.S. banks is so strong that minor problems, or even actually going over the fiscal cliff for a few days, should not weaken it. One metric that we do expect to stop its improving trend is the percentage of reserves to nonperforming loans. For many banks this figure is at or near the high of precrisis levels, allowing banks to release reserves in an effort to boost net income. The boost to net income is needed as an offset to falling net-interest-margin levels as overall fixed-income yields continue to drop. Given the recent actions and comments from the Federal Reserve, we expect falling all-in yields to persist as the latest round of quantitative easing will remain into the foreseeable future, which will force further compression in the net-interest-margin for banks.

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David Sekera has a position in the following securities mentioned above: INTC, EIX. Find out about Morningstar’s editorial policies.