Excerpted from the July 2011 Turnaround Letter issue and Updated October 20^th 2011

Bank stocks have been one of the worst performing groups during the first three quarters of 2011, but we believe that many of them now represent very good long-term values.  While there is still the risk that more negative headlines will keep them under pressure for the short-term, the stocks have been beaten down to levels where they look very cheap.  Below we identify the stocks of ten large banking companies that we believe have very attractive long-term appreciation potential.

Investors have a number of concerns and questions about the bank stocks right now:  How will increased regulation under Dodd-Frank and other laws affect future prospects?  Have the real estate loan problems from 2008 really been resolved?  How will U.S. banks be affected by the latest Greek crisis?  Of course, no one has the answers to these questions and others, and since investors hate uncertainty, they have reacted by dumping bank shares.

We believe that this short-term focus has obscured a longer-term opportunity.  The big banks have cut back on risky practices (either voluntarily or by regulatory decree) and re-focused on their core businesses.  Basic business banking may be less sexy than repackaging subprime mortgages, but in the long run it is less volatile and more profitable.

Many of the large U.S. banks are now trading well below their book value.  Historically, when times are good, bank stocks have traded at two or more times book value.   It could take a couple of years for bank valuations to get back to those levels, but if they do, the appreciation in the stocks will be dramatic.

Moreover, in the meantime, share-holders could be rewarded with increasing dividends and stock buybacks.  Coming out of 2008, the regulators severely restricted dividend payments and stock repurchases by the banks, but the government is gradually loosening these restrictions.

Bank of America has powerful franchises in retail and commercial banking, credit cards, mortgage lending and investment banking. Each of these areas – and particularly the latter two – have caused the bank significant headaches since 2008, but it is beginning to put the problems behind it. The recent mortgage settlement is another step in the right direction. Eventually, the bank’s massive scale should generate huge profits.

Citigroup has a similarly broad reach, but on a global scale. The company’s colossal ambitions almost brought it down in 2008-09. But now as it becomes leaner and more focused by selling off non-core assets, it could finally become the profit machine envisioned by the now-deposed empire-builders.

Fifth Third Bancorp jeopardized its traditional strength in the Midwest by expanding into Florida at exactly the wrong time. The company has gone back to basics and still has a strong franchise in its core markets. Earlier this year, it paid back the last of its Federal crisis funding, and it increased its dividend. We may have been a little early in recommending the purchase of Fifth Third, but we definitely still like it.

JP Morgan Chase managed to avoid most of the pitfalls of its competitors in 2008, and emerged even stronger with moves such as the distressed purchases of Bear Stearns and Washington Mutual. JP Morgan is arguably the premier name in the banking industry today, and it is very rare that you get a chance to buy such a powerful franchise below book value. Management boosted the dividend as soon as the government allowed, and it has recently instituted a $15 billion stock buyback program.

KeyCorp collects the majority of its deposits in Ohio and New York, but operations extend through 12 other states from Alaska to Florida. Management sold the firm’s subprime business in 2006, but that was insufficient to shield it from the meltdown in 2008. Since then, the company’s fortunes have improved, however, including a significant reduction in loss reserves and the repayment of its TARP funds.

PNC Financial Services Group was originally centered in Pittsburgh, but it has expanded across the country with a number of acquisitions. And it is adding to its reach with the announced purchase of the Royal Bank of Canada’s U.S. banking operations. PNC also has a valuable money management and asset servicing business.

Regions Financial conducts banking operations in sixteen Southern states. Many of its markets were among the hardest hit in the residential mortgage crisis. The bank has yet to wade through all of the foreclosures on its books, but it is making good progress. While the ongoing bad loan exposure creates a risk, the stock’s low valuation more than compensates for it.

SunTrust Bank’s banking/financial operations are located in the Southeast, with Florida and Georgia its two largest markets. These were some of the worst performing areas in 2008, but the bank is on the rebound. SunTrust has repaid all of its TARP funds, but it has yet to raise its dividend to a meaningful level. That could happen in the near future.

Synovus, like Regions, is a Southern bank holding company that is still struggling with bad loans. Credit quality is improving, but it still raises concerns. However, the current low stock price magnifies the upside if the company can continue to right itself.

Zions Bancorporation’s strong presence in California, Nevada and Arizona gave it exposure to some of the worst real estate markets in 2008. The bank is on the mend, but still has some more wood to chop. Zions’ strong presence in fast-growing Western markets bodes well for the longer term.

Note: Aggressive investors may want to consider the warrants issued by Bank of America, JP Morgan, PNC and Zions as part of the TARP program. These warrants, discussed in the September 2010 issue, have more gain potential but also more risk than the underlying stock.

Disclosure Note: Accounts managed by an affiliate of the Publisher own securities issued by many of the companies discussed in this article.