UPDATE 2-RBC, long bearish on banks, sees bull market ahead

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By Santosh Nadgir and Jonathan Stempel

BANGALORE/NEW YORK, June 4 (Reuters) - After being bearish on the U.S. banking industry since 2006, RBC Capital Markets analysts upgraded the sector on Thursday to "overweight" from "sector weight," saying the battered industry is in the early stages of a multiyear bull market.

The analysts said recent government "stress tests" of large lenders have given investors a "conservative but realistic" look at a worst-case scenario for the sector, and even if there were near-term pain, longer-term dynamics would be favorable.

Worries over near-term results could cause a 10 percent to 20 percent drop in share prices, which have doubled since early March; but analysts Jon Arfstrom, Jason Arnold, Gerard Cassidy and Joe Morford said this could provide a buying opportunity.

"We have been bearish on bank stocks for over 2-1/2 years due to an expectation that deteriorating credit was going to destroy bank profitability and stock prices," but "two out of the three major risks, capital adequacy and liquidity, for the banking industry have been greatly reduced," RBC said.

The analysts said increases in nonperforming assets, the third risk, should continue into next year. They expect credit costs to peak in 2010 and that, in combination with higher lending margins, should help banks post "stronger earnings in the later part of 2010 and into 2011."

RBC said banks' ability to raise capital quickly since the stress tests were completed a month ago would enable them to recover faster. It also expects many banks to boost dividends over the next 12 to 18 months -- though to lower rates than before the financial crisis hit.

The brokerage raised its rating on Cleveland-based KeyCorp(KEY.N) to "top pick," California's SVB Financial Group (SIVB.O) to "outperform" and Pennsylvania's Fulton Financial Corp (FULT.O) to "sector perform." It also began coverage of Tennessee's First Horizon National Corp (FHN.N) at "outperform."

RBC affirmed its "top pick" rating on Boston's State Street Corp (STT.N) and "outperform" ratings on San Francisco-based Wells Fargo & Co (WFC.N), Minneapolis-based U.S. Bancorp (USB.N), Denver's CoBiz Financial Inc (COBZ.O), Houston's Prosperity Bancshares Inc (PRSP.O), Minnesota's TCF Financial Corp (TCB.N) and Illinois' Wintrust Financial Corp (WTFC.O).

The analysts said they are more optimistic about larger banks than smaller rivals, largely because smaller banks must show they can raise capital "before their shareholders can raise the victory flag."

The KBW Bank Index was up 4.3 percent in afternoon trading. (Reporting by Santosh Nadgir in Bangalore and Jonathan Stempel in New York; Editing by Ratul Ray Chaudhuri and Gerald E. McCormick)