While financial institutions in the Standard & Poor’s 500 Index climbed 24 percent in 2012 for the biggest rally in nine years, they remain 58 percent below the record of February 2007, according to data compiled by Bloomberg. Signs of a housing recovery prompted Wall Street firms to raise estimates for profit growth to 21 percent for the third quarter and 32 percent in the fourth, the most of 10 S&P 500 industries.

Bulls say banks will continue to rally as Federal Reserve stimulus boosts earnings and helps companies from BB&T Corp. to KeyCorp and Wells Fargo & Co. rebound from the 84 percent drop during the financial crisis. Bears say gains will be limited to traditional lenders and increased regulation will drag down firms that depend on trading and underwriting for revenue.

“As transactional volume increases for consumer, housing and business credit, there is an opportunity to increase earnings” among regional lenders, said Michael Shaoul, chairman of New York-based Marketfield Asset Management, which oversees $3 billion. Firms outside of the “purer banking model” face too much regulation, he said in an Oct. 3 e-mail.

Loans Down

Almost five years after the stock market high, real-estate loans among 7,246 federally insured banks have fallen to $4.09 trillion from the record $4.81 trillion reached in 2008, Federal Deposit Insurance Corporation data shows. After declining for 14 consecutive quarters, lending expanded 0.4 percent during the last three months of 2011 and less than 0.1 percent between March and June of this year.

Financial companies still haven’t recovered to pre-crisis levels, with revenue per share at less than half the amount in 2007, according to data compiled by Bloomberg. Tighter rules that limit firms’ trading and call for higher capital requirements and new home sales 70 percent below their record are weighing on investor sentiment.

While banks, brokers and insurers gained 158 percent since equity markets bottomed in March 2009, leading the S&P 500, it would take a rally three times as large to get back to the all- time high. More than $2.4 trillion was erased from the S&P 500 Financials Index’s value from February 2007 to March 2009, as lending froze and writedowns and losses related to subprime mortgages climbed to $2.1 trillion globally.

Futures on the S&P 500 expiring in December fell 0.4 percent to 1,449.4 at 9:28 a.m. in London today.

Profit Estimates

Investors bought shares this year as analysts said profits in the S&P 500 Financials Index will total $154.7 billion in 2012, including $37 billion in the third quarter, according to data compiled by Bloomberg. While that’s down from $222.8 billion in 2007, it’s an increase of 8 percent over last year, Bloomberg data show. More than 30 companies in the 81-stock gauge have been taken out or added into the index in the last five years as their prices plunged and banks merged.

Financial companies make up about 13 percent of S&P 500 earnings. Without them, the projected decline in third-quarter income for the full index would widen to 5.3 percent from 1.7 percent, according to more than 11,000 analyst forecasts compiled by Bloomberg.

Credit from U.S. banks, critical for the economy’s growth, totaled 233 percent of U.S. gross domestic product last year, according to data from the World Bank. Half of likely voters say the economy is the most important issue in the election, according to a survey by Quinnipiac University in Hamden, Connecticut, released last week.

Jobless Rate

Employers added 114,000 workers last month after a revised 142,000 gain in August that was more than initially estimated, Labor Department figures showed Oct. 5 in Washington. The jobless rate dropped to 7.8 percent, the lowest level since President Barack Obama took office in January 2009.

Banks are benefiting as Fed Chairman Ben S. Bernanke buys mortgage bonds to stimulate lending and the economy. The gap between interest charged for residential mortgages and the rates banks pay on securities that package the loans has widened to a record, data compiled by Bloomberg and Bankrate.com show, making home lending more profitable. The increase came as new home sales reached a two year high, even though they remain at less than half their 2005 record.

Shares of banks that focus on real-estate and business lending are climbing the most. The housing rebound and speculation that regulations such as the Dodd-Frank Act will curb earnings at securities firms meant a gauge limited to lenders beat the S&P 500 Financials Index by 5.8 percentage points in 2012.

Banks Advance

The S&P 500 Banks Index of companies such as San Francisco- based Wells Fargo, SunTrust Banks Inc. in Atlanta and Cleveland- based KeyCorp has gained 29 percent this year, on pace for its biggest rally since 1997.

“If you look at loan growth, it’s not robust, but it’s picking up,” said Walter Todd, who oversees about $940 million as chief investment officer of Greenwood Capital in Greenwood, South Carolina. Todd, who spoke in an Oct. 3 phone interview, said his firm owns BB&T Corp. “Whether they meet or miss the near-term expectations, the fundamental backdrop for these domestic-oriented banks is going to continue to improve.”

While S&P 500 earnings will reach a record $102.60 a share this year, third-quarter results may show the first decline since 2009, according to analyst projections compiled by Bloomberg. The growth rate has been slowing since the start of 2011 and was flat for the three months ending in June, as sales slowed and economists cut U.S. growth projections.

Refinancing Rise

For banks, the improvement in home lending reflects a short-term rise in refinancing driven by the Fed and profits show no real growth, according to Peter Kovalski, a fund manager at Alpine Woods Capital Investors LLC in Purchase, New York, that oversees about $5 billion. Chad Morganlander at Stifel Nicolaus & Co. said financial shares may fall as economic growth remains sluggish and Europe’s debt crisis worsens.

“One should be cautious on banks across the board,” Morganlander, a Florham Park, New Jersey-based fund manager at Stifel Nicolaus, which oversees about $138 billion in client assets, said in an Oct. 3 phone interview. “Until household credit is created without monetary or fiscal stimulus, then bank stocks are going to have a tough time providing long-term leadership.”

Consumer debt has declined to $11.4 trillion as of the second quarter of 2012, from a peak of $12.7 trillion in 2008, according to Fed data. Financial company borrowings fell $3.3 trillion to $13.8 trillion, the data show.

GDP Growth

Expansion of America’s gross domestic product is forecast to slow to 2.05 percent in 2013 from 2.2 percent this year, according to the median estimate of economists surveyed by Bloomberg.

Financial companies’ revenue reached $35.56 per share last quarter, less than half the $80.65 high in 2007, weighed down by a compression in net interest margins, or the difference between what banks pay for deposits and charge for loans. The spread at U.S. banks with more than $15 billion in assets dropped to 3.29 percent last quarter from 3.85 percent in the first quarter of 2010, according to data from the Federal Reserve Bank of St. Louis.

Charles Bobrinskoy at Ariel Investments says that while regulation requiring higher capital cushions to protect against losses and more scrutiny by the government will constrict bank earnings growth, investors may be undervaluing their potential.

Priced In

“If there are new regulations on what businesses we can be in, if there are new regulations on leverage, anti-credit card fees, all of the things that Washington can do, it can be a negative,” Bobrinskoy, director of research at Ariel in Chicago, said in an Oct. 3 Bloomberg Television interview. “Those are all priced into the stocks, and I think from here we’ve got a lot of upside.”

Real-estate loans 90 days or more past due totaled $112.5 billion in the second quarter, according to the FDIC. While that’s more than twice as much as the end of 2008, nonperforming loans dropped 2 percent for the three months through June and 0.8 percent the quarter before, data show.

Shares of BB&T Corp. are 29 percent below the record in December 2006. The Winston-Salem, North Carolina, company beat second-quarter profit projections as deposits rose, net interest margin expanded and provisions for credit losses fell.

BB&T, which gets about half its operating income from the banking network for retail and small clients and the residential mortgage business, increasing return on common equity to 9.6 percent in the second quarter, and is forecast to expand earnings more than 30 percent for each of the next two reports.

Credit Quality

Analysts project Wells Fargo will boost earnings 20 percent in the third quarter and 21 percent the next, according to Bloomberg data. The company, which broke a profit record in 2011 and posted the highest second-quarter return on equity among the six largest banks, is 10 percent below its stock record.

“Credit quality -- the prime mover of bank fundamentals -- is poised to get better than average,” Chris Kotowski, a New York-based analyst with Oppenheimer & Co., wrote in a Sept. 25 note. He recommends investors overweight banks. “In its wake, steady loan growth and margins should follow.”

Credit card debt 90 days past due declined every quarter except one since June 2010, according to FDIC data. The $7.5 billion outstanding is less than half the amount at the start of that year.

“As the economy continues to improve, there should be a lot more improvement ahead for bank earnings,” said Timothy Ghriskey, the chief investment officer at Solaris Group LLC, which manages about $2 billion in Bedford Hills, New York. He spoke in an Oct. 3 phone interview. “Ultimately, stock prices follow earnings.”