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8 Post-Downgrade Bank Stock Bargains

Tickers in this article: GS C STI BAC I:BKX MS KEY CMA ZION

NEW YORK ( TheStreet) -- Now is the time for long-term investors to consider building positions in heavily discounted bank stocks.

Following last week's decent showing for bank stocks in the wake of ratings downgrades by Moody's Investor Service, increasing clarity on banks' enhanced regulatory capital requirements, continued U.S. economic reports showing a growth slowdown, and signs that European leaders could muddle their way through saving the common currency, heavily discounted high-volume bank stocks may be able to begin recovering to levels reached earlier this year.

The KBW Bank Index (I:BKX) closed at 45.09 Friday, up 1% for the week and up 14.5% year-to-date, however, the index was down 10% from its closing high of $50.26 on March 26.

For the investment banks, the ratings downgrades announced by Moody's act as something of a "reset" for Morgan Stanley (MS) and Goldman Sachs (GS) , especially after the ratings firm surprised investors -- and apparently even Morgan Stanley -- with a two-notch downgrade , instead of the expected three-notch downgrade.


With investor jitters continuing for Morgan Stanley over weak second-quarter revenue prospects in a tepid economy, even Deutsche Bank analyst Michael Carrier -- who sees 41% upside for the shares, based on a $20 price target and Friday's closing price of $14.14 -- rates the shares a "Hold."

So why should investors consider Morgan Stanley? One reason is that the shares of this profitable investment bank trade for just over half their reported March 31 tangible book value of $27.37. The company is also very strongly capitalized, with a Basel I Tier 1 common capital ratio of 13.3% as of March 31, increasing dramatically from 12.7% the previous quarter and 8.9% a year earlier.

Under Basel III, allowable Tier 1 capital will be reduced, while risk-weighted assets will increase, pushing the Tier 1 common ratio down, but banks have until January 2019 to achieve full compliance with the new capital standards, and Morgan Stanley estimated in its first-quarter 10-Q filing that "its pro forma Tier 1 common capital ratio under Basel III will be in a range between 8% and 10% by the end of 2012." With a minimum Tier 1 common equity ratio requirement of 7.5%, plus a possible 2.5% capital buffer required as a "systemically important financial institution," Morgan Stanley could conceivably comply with the enhanced capital requirements by the end of this year, or five-years before the fully phase-in of Basel III requirements.

Under new regulatory guidance for "advanced banks," Citigroup analyst Keith Horowitz on Thursday estimated that Morgan Stanley's pro forma Basel III Tier 1 common equity ratio would be 8.5%, which is within the range of 8% to 9% that Morgan Stanley CEO James Gorman recently estimated. That's considerably higher than Citi's estimates for JPMorgan Chase , Goldman Sachs , Bank of America and Wells Fargo , although, of course, several of those names have been posting higher recent returns on equity than Morgan Stanley.