Financials are soaring this morning on a Goldman Sachs upgrade of the banking sector. Goldman likes the banks based on valuation and the reduced government involvement.  Although they see another $500B in write-downs across the banking sector they believe the heavy lifting has been done and pressures should ease on the banks as the economy continues to improve and lending markets climb back to full health.  Attached are the 10 reasons Goldman still loves the banks and how to play it.

• Government intervention a concern for investors in intermediate term

- Resolution trust authority in the US, potential dividend/coupon deferrals in Europe,   consumer protection
schemes, higher capital levels.

• Default risk at most banks low as liquidity improved and emergency support systems remain.

• Additional balance sheet management (debt exchanges/tenders below par, equity issuance, asset sales, Tier 1 hybrid issuance) likely globally to improve core Tier 1 levels.

• Asset quality and future levels of profitability remain concerns in coming quarters.

• HY financials are still under pressure – tight liquidity and concerns over business model viability persist.

• Despite significant spread tightening in recent months, banks still look inexpensive to non-financials, especially in
  the US and certain parts of Tier 1 sector.

• Volatility to remain, some profit taking should be expected after performance in last few months, but value remains
  heading into 2010.

• Cash should continue to outperform CDS, especially if exchanges/tenders continue. Be wary of new Tier 1 structures vis a vis investor rights.

• The non-guaranteed new issue markets have reopened for many banks, but supply is manageable as liquidity is plentiful and investor demand remains solid.

• European banks have now started to raise equity to replace government support – positive for debt.

How to play it?

Goldman likes Bank of America as the Merrill acquisition pays dividends, Barclays as a recovery play, Capital One on valuation, HSBC on strong management/valuation, ING on strong fundamentals, JP Morgan on global position, Santander global strength and Standard Chartered on lack of government aid and global diversity.

Banks they don’t like: BNP, Deutsche Bank, Wells Fargo, Citi, and Unicredit

Source: Goldman Sachs