Last year has been brutal for investors in European bank stocks. Compared to the plunge of 25% for US bank stocks as measured by The KBW Bank Index, the STOXX Europe 600 Banks Index was down about 33% in Euros. Many individual European bank stocks have performed much worse with none of their exchange-traded ADRs in positive territory for the year.

The following five worst performing European bank ADRs were:

1.Bank:Bank of Ireland (IRE)
2011 Price Change: -84.0%
Country: Ireland

2.Bank:National Bank of Greece (NBG)
2011 Price Change: -84.0%
Country:Greece

3.Bank:Lloyds Banking Group (LYG)
2011 Price Change: -76.0%
Country: UK

4.Bank:Royal Bank of Scotland (RBS)
2011 Price Change: -62%
Country: UK

5.Bank:Credit Suisse (CS)
2011 Price Change: -42.0%
Country:Switzerland

According to a “2010 Investment Outlook” report by Absolute Return Partners LLP of UK, European banks could be the main story this year. Some of the key points noted by them are:

• European banks must raise Tier 1 Capital Ratios to 9% by the end of June 2012.
• The European Banking Authority(EBA) estimates a total of €106 billion of new capital will be required.
• With most bank stocks selling well below book value and with earnings under pressure, few are keen to raise new equity capital.
• The alternative is to delever with Morgan Stanley estimating that between €1.5-2.5 Trillion of deleveraging to occur over the next 18 months (or 3-5% of total assets).
• Barclays Capital puts the figure as high as 10%.
• With political pressure to continue domestic lending,banks may cut back on non-domestic lending.
• Since banks have to shrink assets by as much as 10% to meet the 9% Tier 1 Capital Ratio target, they may pull out of Central and Eastern Europe where non-performing loans are high.

Source: Absolute Return Partners LLP

In addition to issues facing the banking sector, recently some economic experts have suggested that recession has already returned to Europe.  Hence from an investment standpoint investors may want to completely avoid European bank stocks in 2012.

Disclosure: Long LYG