With the industry continuing to build capital, and with the strong recovery this year, there are many fewer big banks trading below book value. Bank of America now trades for 0.9 times tangible book value, but the shares look rather expensive, trading for 11.8 times the consensus 2013 earnings estimate of 96 cents, among analysts polled by Thomson Reuters. A silver lining for the shares is that the consensus 2014 EPS estimate is $1.25, portending a relatively large jump in earnings another year out, as the company works to cut expenses. Investors are also looking for a significant boost in the company's return of capital, following the next round of Federal Reserve stress tests, which will be completed in March.
The increased return of capital though higher dividends and share buybacks will be a major theme for most of the big banks in 2013. While many investors rightly fear that the U.S. economy could slip back into recession without a compromise in Washington to avoid the "fiscal cliff," the Fed's stress tests include a "severely adverse scenario" for a difficult recession in 2013, and most bank analysts think that the large banks will still be approved for dividend increases and significant buybacks.
The banking industry will also continue to face a rough interest rate environment, as the Federal Reserve is maintaining its "highly accommodative" policy of making large monthly purchases of mortgage-backed securities and U.S. Treasury securities in order to keep long-term rates at their historically low levels. The short-term federal funds rate has been kept in a target range of zero to 0.25 percent since late 2008, meaning most banks are feeling the squeeze, as they have already realized most of the benefits of lower funding costs, while their assets continue to reprice at lower rates.
Banks are looking to offset the declining net interest margins through continued strength in fee income from the mortgage refinance wave, with gains on the quick sale of newly originated loans to Fannie Mae and Freddie Mac. Improving credit quality will also boost earnings through the release of loan loss reserves, although this is expected to subside during 2013, with some banks beginning to build reserves again.
While many banks will still not be back to "normalized earnings" performance during 2013, the combination of stronger capital, stronger liquidity, the housing recovery and credit improvement, expense reductions, and capital turns, all bode well for a continued recovery of bank stock prices.
With low multiples to book value having less meaning at this point in the credit cycle, we have used data provided by Thomson Reuters Bank Insight to isolate the 10 actively traded bank stocks — with average daily trading volume of over 50,000 shares — trading at the lowest multiples to consensus 2013 operating earnings estimates.
Here they are, in order from the highest forward P/E to the lowest:
10. Regions Financial
Shares of Regions Financial of Birmingham, Ala., closed at $6.93 Friday, returning 62 percent year-to-date, following a 38 percent decline during 2011.
The shares trade for just over their tangible book value, according to Thomson Reuters Bank Insight, and for nine times the consensus 2013 earnings estimate of 77 cents a share, among analysts polled by Thomson Reuters. The consensus 2014 EPS estimate is 82 cents.
This year has been a transformational year for Regions, with the company selling its Morgan Keegan brokerage subsidiary to Raymond James Financial for $900 million and raising another $930 million through a common equity offering during the first quarter. During the second quarter, Regions fully redeemed $3.5 billion in preferred shares held by the government for bailout assistance received in November 2008 through the Troubled Assets Relief Program, or TARP.
The Wall Street Journal on Dec. 24 reported that the Regions was being investigated by federal bank regulators, the Securities and Exchange Commission and the TARP Special Inspector General for improperly accounting for nonperforming loans during the financial crisis.
Regions didn't return a call requesting comment on the investigation, but Miller Tabak analyst Thomas Miller wrote last Monday that the investigation of the company's accounting was " not 'new news,' and the malefactors, if there were any, are long gone from RF's management. Management has aggressively addressed problem loans, and loan classification processes, in recent quarters, and we take the bank's recent improving credit metrics as a sign that a very substantial percentage of RF's recession legacy problem loans have been fully addressed."
Miller added that "the investigations well may lead to RF paying a modest settlement and agreeing to maintain better practices — practices already implemented — in future periods."
Assuming Miller is correct about a "modest settlement," the patience of Regions Financial's long-term investors may be rewarded with a significant dividend increase during 2011. Guggenheim analyst Marty Mosby rates Regions a "buy," with a price target of $9, and estimates that the company will raise its quarterly dividend from a penny a share to a nickel following the stress tests.
9. Oriental Financial Group
Shares of Oriental Financial Group of San Juan, Puerto Rico, closed at $13.15 Friday, returning 11 percent year-to-date, after pulling back 1 percent during 2011.
The shares trade for 0.9 times tangible book value, and for 8.9 times the consensus 2013 EPS estimate of $1.48. The consensus 2014 EPS estimate is $1.75.
Based on a quarterly payout of six cents, the shares have a dividend yield of 1.83 percent.
Oriental Financial had $6.1 billion in total assets as of Sept. 30, having greatly expanded its share of the Puerto Rico market through its purchase of the failed Eurobank from the Federal Deposit Insurance Corp. in April 2010.
The company on Dec. 18 completed its acquisition of the Puerto Rico operations of Banco Bilbao Vizcaya Argentaria for $500 million in cash, bringing on roughly $5 billion in additional assets, as well as $3.7 billion in loans.
After the BBVA deal was approved, KBW analyst Derek Hewitt on Dec. 10 said in a report that his firm was "excited about this accretive transaction which will allow OFG to fully deploy its excess capital, become one of the leading commercial banks on the island, and should generate a more stable revenue stream from higher multiple commercial banking activities."
With loans making up just 26 percent of Oriental's total assets as of Sept. 30, Hewitt said that the BBVA deal would "transform OFG's earning asset mix from that of an agency-REIT to a commercial bank."
The analyst rates Oriental Financial Group "outperform," with a $15 price target, and wrote that "investors have not fully incorporated the expected earnings accretion from this deal; therefore, the shares remain attractively priced" at just over roughly at Hewitt's pro forma Dec. 31 tangible book value estimate of $12.79.
8. Discover Financial Services
Shares of Discover Financial Services closed at $37.99 Friday, returning 60 percent year-to-date, following a 31-percent return during 2011.
The shares trade for 2.2 times tangible book value, and for 8.8 times the consensus fiscal 2013 EPS estimate of $4.33. The consensus fiscal 2014 EPS estimate is $4.49.
The company on Dec. 20 raised its quarterly dividend by 40 percent to 14 cents. Based on the increased payout, the shares have a dividend yield of 1.47 percent. The company repurchased 10 million common shares during the fiscal fourth quarter for $401 million, and was authorized under its current stock repurchase plan to buy back roughly $800 million worth of additional shares.
Discover's valuation and the fantastic track record for the shares even during a very difficult 2011 for the banking industry, reflect a strong and consistent earnings track record. For its fiscal fourth quarter ended Nov. 30, the company reported net income allocated to common shareholders of $551 million, or $1.07 a share, declining from $627 million, or $1.21 a share the previous quarter, but increasing from $513 million, or 95 cents a share, a year earlier.
Discover reported a fiscal fourth quarter return on equity of 23 percent, compared to 28 percent the previous quarter. Earnings declined sequentially because the company increased its provision for loan losses to $338 million from $126 million in the fiscal third quarter. The provision for loan losses was $319 million during the 2011 fiscal fourth quarter.
Guggenheim analyst David Darst on Dec. 20 wrote that Discover's "reserve release has ended, but credit cost remains low, resulting in a strong ROE and providing opportunity to invest in the payments business." The analyst added that "has multiple levers to drive profitability and growth; however, we expect higher provisioning to limit EPS growth in 2013/14. Despite this dynamic, consensus estimate revisions remain positive and the shares trade at an attractive valuation that does not fully reflect payment partnership opportunities, in our view."
Darst rates Discover a "buy," with a $48 price target, and estimates the company will earn $4.44 a share in 2013, with EPS climbing to $4.50 in 2014.
7. PNC Financial Services Group
Shares of PNC Financial Services Group of Pittsburgh closed at 57.46 Friday, returning 2 percent year-to-date, following a 3 percent decline during 2011.
The shares trade for 1.1 times tangible book value, and for 8.7 times the consensus 2013 EPS estimate of $6.59. The consensus 2014 EPS estimate is $6.93.
Based on a quarterly payout of 40 cents, the shares have a dividend yield of 2.78 percent.
Oppenheimer analyst Terry McEvoy on Nov. 26 reiterated his "Buy" rating for PNC, but lowered his price target to $72 from $75, "in light of the compression in bank stock valuations and the negative EPS revisions post 3Q12 earnings."
PNC reported third-quarter net income of $825 million, or $1.64 a share, increasing from $546 million, or 98 cents a share in the second quarter, and $834 million, or $1.55 a share, in the third quarter of 2011. The sequential earnings improvement reflected second-quarter items totaling $403 million after tax, or 76 cents a share, including "$284 million after tax, or $.54 per diluted common share, for a provision for residential mortgage loan repurchase obligations, noncash charges of $85 million after tax, or $.16 per diluted common share, related to redemption of trust preferred securities and integration costs of $34 million after tax, or $.06 per diluted common share."
During the third quarter, PNC's net interest margin — the difference between the average yield on loans and securities investments and the average cost for deposits and borrowings — narrowed to 3.82 percent from 4.08 percent the previous quarter and 3.89 percent a year earlier. The company said the sequential margin decline included 16 basis points "due to lower purchase accounting accretion."
McEvoy said that "PNC provides guidance on potential levels of purchase accounting accretion and believes levels will decline $400M in FY13 to ~$650M. We understand that this revenue is not 'core' in nature but that it does flow into capital. Backing out purchase accounting accretion from our 2013E EPS would suggest 'core' earnings of ~$5.35."
The analyst is still positive on PNC, because the company's acquisition of RBC Bank in the first quarter "provides the right size retail platform in that it allows PNC to be a known banking entity without the expense drag of having a branch on every corner. PNC is ahead of the industry when it comes to transitioning customers into less expensive non-branch delivery channels."
Shares of Popular of Hato Rey, Puerto Rico, closed at $13.90 Friday, returning 47 percent year-to-date, following a 56 percent decline during 2011.
The shares trade for 0.6 times tangible book value, and for 8.7 times the consensus 2013 EPS estimate of $2.35. The consensus 2014 EPS estimate is $2.77.
The company owes $935 million in TARP money.
Popular had $36.5 in total assets as of Sept. 30. The company reported third-quarter net income applicable to common stock of $46.3 million, or 45 cents a share, declining from $64.8 million, or 63 cents a share, in the second quarter, but increasing from $26.6 million, or 26 cents a share in the third quarter of 2011.
The second-quarter results reflected a $72.9 million income tax benefit related to the company's purchase of the failed Westernbank Puerto Rico from the FDIC in April 2010, as well as "unfavorable adjustments in the quarterly valuation of loans held-for-sale of $27.3 million."
The year-over-year earnings improvement mainly reflected a decline in the provision for loan losses not covered by the FDIC loss-sharing agreement to $83.6 million in the third quarter, from $150.7 million, a year earlier. This improvement was partially offset by a decline in third-quarter net interest income to $343.4 million from $369.3 million a year earlier, as loan balances declined and the net interest margin narrowed to 4.37 percent in the third quarter from 4.45 percent in the third quarter of 2011.
Popular provided earnings guidance, for a profit ranging from 50 cents to 65 cents a share in the fourth quarter.
KBW analyst Derek Hewitt rates Popular "outperform," with a $24 price target, saying on Oct. 22 after the company reported its third-quarter results that the company's capital levels were "looking good," with a tangible common equity ratio of 9.3 percent, but that "TARP redemption not a near-term event."
Hewitt said that Popular's credit trends were "mostly positive," with nonperforming assets "relatively flat" at $1.8 billion as of Sept. 30, or 8.58 percent of total assets, reflecting the long-term recession in Puerto Rico
The analyst estimates that the company will earn $2.50 a share in 2013.
Shares of Citigroup trade for 0.7 times tangible book value, and for 8.4 times the consensus 2013 EPS estimate of $4.65. The consensus 2014 EPS estimate is $5.14.
Citigroup has come a long way during 2012, with the company's estimated Basel III Tier 1 common equity ratio increasing to 8.6 percent as of Sept. 30, from 7.2 percent six months earlier.
Former CEO Vikram Pandit's long-term "good bank/bad bank" strategy of placing non-core assets in the Citi Holdings subsidiary and then selling them or allowing them to run-off has trimmed the company's balance sheet, while also reducing expenses. This strategy is being accelerated by new CEO Michael Corbat.
The company on Dec. 5 announced a series of moves meant to cut its annual expenses by $900 million in 2013, with total expense savings increasing to $1.1 billion in 2014. The cuts included 84 branches and 111,000 layoffs, with the company estimating that its annual revenue would decline by only $300 million.
Citigroup currently pays a nominal quarterly dividend of a penny a share. The company's initial 2012 capital plan included a dividend increase and share buybacks, but was rejected by the Federal Reserve. A revised capital plan was approved in August, but included no request for any increased capital return to shareholders.
Marty Mosby of Guggenheim Securities estimates that Citigroup had $14.9 billion in excess capital as of Sept. 30, and estimates that following the next round of stress tests, the company will receive Fed approval to raise the dividend to 25 cents a share, with the company holding off on share buybacks for another year.
Mosby rates Citigroup a "buy," with a $50 price target, and estimates the company will earn $4.85 a share in 2013, with EPS rising to $5.55 in 2014.
4. JPMorgan Chase
Shares of JPMorgan Chase closed at $43.24 Friday, returning 34 percent year-to-date, following a 20 percent decline during 2011.
The shares trade for 1.3 times tangible book value, and for 8.2 times the consensus 2013 EPS estimate of $5.29. The consensus 2014 EPS estimate is $5.69.
Based on a quarterly payout of 30 cents, the shares have a dividend yield of 2.78 percent.
JPMorgan was approved in March to repurchase $12 billion in common shares through the end of 2012, followed by another $3 billion in the first quarter of 2012. After suspending the buybacks in May because of trading losses by its Chief investment Office, the company announced that in November that the company would resume buybacks in the first quarter of 2013, repurchasing up to $3 billion in shares.
While the company and its shares took quite a hit during the second quarter from the CIO trading loss, with the hedge trades leading to total losses of $4.4 billion in the second quarter and $449 million in the third quarter, JPMorgan managed still to earn $5.0 billion in the second quarter, and $5.7 billion in the third quarter. The company's estimated Basel III Tier 1 common equity ratio was 8.4 percent as of Sept. 30, increasing from 7.9 percent the previous quarter.
Following the 2013 stress tests, Guggenheim Securities analyst Marty Mosby expects the company to be approved to raise the quarterly dividend to 40 cents and buy back up to $11.6 billion in shares.
Mosby rates JPMorgan Chase a "buy," with a $55 price target, and estimates the company will earn $5.60 a share during 2013, with earnings increasing to $6.60 a share in 2014.
3. Capital One Financial
Shares of Capital One Financial closed at $57.10 Friday, returning 36 percent year-to-date, following a flat return during 2011.
The shares trade for 1.5 times tangible book value, and for 8.1 times the consensus 2013 EPS estimate of $7.01. The consensus 2014 EPS estimate is $7.38.
This year has been a transformative year for Capital One, with the company's acquisition of ING Direct in February, a $1.25 billion common equity raise in March, and the purchase of HSBC's U.S. credit card portfolio in May, for a premium of $2.5 billion. The ING deal included roughly $80 billion in deposits gathered over the Internet, along with $41 billion in loans, providing plenty of liquidity for the $28.2 billion in credit card loans acquired from HSBC.
The third quarter was the first "clean quarter" for Capital One during 2012, as the company moved past the bulk of one-time items related to the acquisitions. Third-quarter earnings available to common shareholders totaled $ $1.17 billion, or $2.01 a share, excluding income from discontinued operations.
The company's net interest margin was 6.97 percent in the third quarter, increasing from 6.04 percent the previous quarter (when the company's margin declined because of the ING acquisition, without yet realizing a full quarter's benefit from the HSBC cards), but narrowing from 7.40 percent a year earlier. The year-over-year narrowing of the margin is in line with the industry, in the prolonged low-rate environment.
Capital One's third-quarter return on average assets was 1.60 percent and its return on average tangible equity was 21.48 percent, compared to ROA of 1.72 percent and ROTCE of 22.58 percent a year earlier, moving the company back to its expected strong earnings level as a lender focused on card lending.
FBR analyst Paul Miller on Dec. 19 included Capital One among his list of "stocks to own for 2013," with a price target of $72, saying the company is "one of our favorite names due to its compelling valuation ($72 target = 10x our FY13 EPS estimate and 1.1x book value), expected resumption of the dividend, and increased earnings power."
FBR estimates that Capital One will earn $7.15 a share in 2013, followed by EPS of $7.25 in 2014.
2. Flagstar Bancorp
Shares of Flagstar Bancorp of Troy, Mich., closed at $18.85 Friday, returning a whopping 270 percent year-to-date, following a 69-percent decline during 2011, adjusted for a one-for-10 reverse split after the market closed on Oct. 10.
The shares trade for 1.1 times tangible book value, and for 5.1 times the consensus 2013 EPS estimate of $3.71.
The company owes $266.7 million in TARP money. Flagstar in October announced that its main subsidiary Flagstar Bank had entered into a consent order with the Office of the Comptroller of the Currency, requiring the bank to "adopt or review and revise various plans, policies and procedures related to, among other things, regulatory capital, enterprise risk management and liquidity." Flagstar Bank CEO Joseph Campanelli said in a press release that "The matters reflected in the Consent Order were initially brought to our attention earlier this year by the OCC in connection with its examinations of the Bank," as part of a transition from being regulated by the Office of Thrift Supervision to being regulated by the OCC.
Campanelli said that "for much of this year, the Bank has been devoting significant attention and resources to addressing the matters identified in the Consent Order and developing or refining the relevant plans, policies and procedures. We have already made significant progress, and the Bank's Board of Directors is committed to working closely with the OCC and to achieving full compliance with the provisions of the Consent Order."
Flagstar's earnings have improved dramatically as the company has taken advantage of the mortgage refinancing wave. The company reported third-quarter net income available to common stockholders of $79.7 million, or $1.36 a share, compared to $85.6 million, or $1.47 million a share, during the second quarter, and a net loss to common stockholders of $14.2 million, or 26 cents a share, during the third quarter of 2011.
The main factor in the earnings improvement has been gains on the sale of newly originated mortgage loans, which totaled $334.4 million in the third quarter, compared to $212.7 million the previous quarter, and $103.9 million a year earlier. The third quarter results were affected by a $124.5 million provision for mortgage repurchase demands.
FBR analyst Paul Miller rates Flagstar "outperform," with a $25 price target, and on Dec. 19 said that he expected the company would "be able to out-earn remaining legacy credit and litigation costs."
"With a valuation now just over current tangible book value of $17.76," Miller said that "the early part of 2013 will be key for Flagstar to continue recent stock price appreciation through book value growth. With sustainable profitability well within the company's capabilities, the next several quarters will be critical as FBC looks to realize back its $309 million [deferred tax asset] valuation allowance and to repay TARP capital."
Miller estimates that Flagstar will earn $3.92 a share in 2013, factoring-in the DTA recapture, with a 2014 EPS estimate of $3.40.
Shares of HomeStreet of Seattle closed at $25.25, Friday, returning 110 percent (adjusted for stock splits) since the company went public on Feb. 14. The shares underwent a two-for-one split on Nov. 8, following a previous two-for-one split in March.
HomeStreet trades for 1.5 times tangible book value, and for five times the consensus 2013 EPS estimate of $5.02.
The company had $2.5 billion in total assets as of Sept. 30. Earnings have been very strong since the company went public, with returns on average assets ranging from 3.04 percent to 3.50 percent over the past three quarters, according to Thomson Reuters Bank Insight, while the return on average tangible common equity has ranged between 35.61 percent to 39.95 percent, for what is, by far, the strongest earnings performance among the 10 banks being discussed here.
HomeStreet focuses on originating mortgage loans, including single family loans and multifamily loans through its HomeStreet Capital subsidiary. The company reported total third-quarter originations of single-family mortgage loans designated for sale of $1.4 billion, increasing from $1.1 billion the previous quarter, and $480 million a year earlier.
Third-quarter earnings totaled $21.3 million, or $2.90 a share, increasing from $18.0 million, or $2.42 million, in the second quarter, and $15.3 million a year earlier (before the company went public).
HomeStreet CEO Mark Mason explained that the company was continuing "to realize the benefits in origination volume and market share from our continued focus on recruiting top production and support personnel in our markets."
The company has also been able to buck the industry trend, with its third-quarter net interest margin expanding to 3.08 percent from 2.83 percent the previous quarter and 2.38 percent a year earlier, "reflecting improvement in asset yields in part as a result of new lending and expected decreases in our cost of deposits," according to Mason.
FIG Partners analyst Timothy Coffey rates HomeStreet "Outperform," with a price target of $40, saying in October after the split was announced that "the stock benefits from significant growth in tangible book value from an underappreciated mortgage banking business. HMST originated more than $1 billion in mortgage loans (residential and multifamily) for the second consecutive quarter in 3Q-12 and sold them at an estimated net margin of 3.28 percent, which is an exceptionally strong number compared to the estimated net margin of 1.72 percent in 3Q-11."
The analyst said that "HMST is a stock that should approach a normalized P/E ratio of 10x forward EPS, but until then is likely to trade at increasing multiples to tangible book value," and that the stock has been "hindered by relative obscurity having IPO'd earlier this year, optically troubled credit quality (although [nonperforming assets], excluding restructured credits, are a benign 4.22 percent of Loans Held for Investment [repossessed real estate]) and a pair of regulatory orders (that we anticipate are lifted shortly)."
The company is operating under regulatory orders initially entered into during 2009 with the Office of Thrift Supervision agreeing to "augment regulatory capital and reduce problem assets." The OTS order is now administered by the OTS. HomeStreet expects the orders soon to be lifted, as a similar order by State Regulators and the Federal Deposit Insurance Corp. covering main subsidiary HomeStreet Bank was lifted in March, and because the company was quite strongly capitalized with a regulatory Tier 1 leverage ratio of 10.8 percent and a total risk-based capital ratio of 17.9 percent, as of Sept. 30.
Asset quality has also improved dramatically, with nonperforming assets making up 2.20 percent of total assets as of Sept. 30, compared to 3.04 percent the previous quarter and 6.88 percent a year earlier.
Coffey estimates that HomeStreet will earn $6.78 a share in 2013, improving from an estimated $5.18 a share in 2012. The analyst also expects "the initiation of a quarterly $0.20 per share cash dividend starting in 1Q-13," although "the company has not announced such a dividend plan yet."
—By TheStreet.com's Philip van Doorn
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