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5 Regional Banks to Watch Heading Into Earnings

Philip van Doorn | TheStreet.com Bank Analyst
Tuesday, 2 Apr 2013 | 3:28 PM ET
Davis Turner | Bloomberg | Getty Images

Heading into first-quarter earnings season, efficiency is the name of the game for big U.S. banks.

Most large banks are continuing to see their net interest income pressured in the prolonged low-rate environment. With the short-term federal funds rate staying in a range of zero to 0.25 percent since late 2008, most of the big players have already realized the benefits on the cost side. Meanwhile, higher-rate residential mortgage loans continue to be refinanced and commercial loans continue to reprice at lower rates. The FDIC reported the aggregate net interest margin for U.S. banks narrowed to 3.32 percent in the fourth quarter from 3.43 percent in the third quarter and 3.57 percent in the fourth quarter of 2011.

There has been upward pressure in the market on long-term rates, anticipating the eventual change in the Federal Reserve's policy of holding down rates through large monthly purchases of long-term securities. Market rates on 10-year U.S. Treasury securities during the first quarter ranged from 1.84 percent to 2.07 percent, increasing from a range of 1.58 percent to 186 percent in the fourth quarter. But Deutsche Bank analyst Matt O'Connor on March 22 said in a report that banks' net interest margins "are likely to remain under pressure from continued low absolute rates and likely increasing loan pricing pressure."

According to the Federal Reserve, average loans for U.S. banks increased by 2 percent through March 22, from the fourth quarter. The growth rate was down from 4 percent in the fourth quarter. Jefferies analyst Ken Usdin on Monday said in a report, "on the mortgage banking front, the drivers of fees are starting to weaken with both average mortgage applications (down 4 percent quarter-to-quarter) and average gain-on-sale margins (down 13 percent) compressing. We expect total origination volume to decline throughout the year as the refi fall-off outpaces the purchase pick-up."

While some smaller regional lenders are seeing increasing commercial loan demand, it would appear that most banks will continue to focus on making their operations leaner in order to wring every last bit of expense savings.

At this stage of the credit recovery, many banks continue to bear outsized expense levels as they work through problem loans and repossessed real estate. The unfortunate aspect of improvements in these areas is a wave of staff layoffs, which will continue until the banks feel the need to add production staff.

A bank's efficiency ratio is, essentially, the number of pennies of expenses it incurs for each dollar of revenue. It's not surprising to see banks with the greatest credit overhang having the highest (worst) efficiency ratios; investors can expect plenty of discussion on efficiency ratios and cost cutting during first-quarter earnings calls.

According to data provided by Thomson Reuters Bank Insight, Bank of America had a 2012 efficiency ratio of 84.11 percent in 2012, improving slightly from 84.52 in 2011. This was the highest efficiency ratio among the 24 components of the KBW Bank Index, which is hardly surprising, since Bank of America, through its ill-timed acquisition of Countrywide Financial in 2008, has, by far the greatest number of problem mortgage loans, repossessed properties, and repurchase demands from investors to deal with.

Among major regional players, U.S. Bancorp of Minneapolis had the best efficiency ratio of 52.07 percent in 2012, improving slightly from 52.40 percent in 2011. The company's excellent efficiency ratio is reflected in its very strong earnings performance, with a 2012 operating return on average assets (ROA) of 1.65 percent and return on average tangible common equity of 20.80 percent, according to Thomson Reuters Bank Insight.

Some Bank Stocks Are Still Quite Cheap

The financial industry's recovery has continued in full swing, with the KBW Bank Index rising 10 percent this year through the end of March, following a 30 percent return during 2012. All 24 components of the index showed year-to-date gains, with the notable exception of Capital One Financial with shares declining 5 percent through Thursday's close at $54.95.

Capital One's underperformance reflects a disappointing fourth quarter and subdued outlook for 2013, with weak credit card loan demand in the U.S. The company last month agreed to sell its $7 billion portfolio of Best Buy credit cards to Citigroup, in a deal that is expected to be completed in the third quarter.

The weak demand for Capital One's core product is reflected in the market valuation for the shares, which trade for 8.2 times the consensus 2014 earnings estimate of $6.68, among analysts polled by Thomson Reuters. At Thursday's market close, only four other components of the KBW Bank Index traded for 9.5 times forward earnings, or lower:

  • Shares of JPMorgan Chase closed at $47.46, trading for 8.2 times the consensus 2014 earnings estimate of $5.81 a share.
  • Citigroup closed at $44.24, trading for 8.5 times the consensus 2014 EPS estimate of $5.23.
  • Shares of Bank of America closed at $12.18, trading for 9.4 times the consensus 2014 EPS estimate of $1.30.
  • Wells Fargo closed at $36.99, trading for 9.5 times the consensus 2014 EPS estimate of $3.89.

So Capital One is lumped in with the "big four" U.S. banks, which have regulatory and political targets on their backs and are still trading at historically cheap valuations, especially JPMorgan Chase and Wells Fargo, which continue to be solidly profitable.

Bank of America continues to clean up its legacy mortgage mess, which of course includes the potential for several more brutal headlines over the next year or two. Citigroup continues its transformation and, with the company making a modest request for Federal Reserve approval to repurchase $1.2 billion worth of common shares through the first quarter of 2014 and with no dividend increase, the company should continue to rapidly build up excess capital.

With its relatively low valuation and credit card business model, Capital One appears to be a good defensive play among bank stocks. Following the completion of the Federal Reserve's annual round of stress tests, the company raised its quarterly dividend to 30 cents a share from 5 cents, for a dividend yield of 2.18 percent.

When considering the low valuation of the big four, the market is sending a pretty clear signal that the large regional banks will be the ones to see the most earnings growth as economic activity continues to recover.

Stress Tests, Buybacks and Higher EPS

Aside from the grilling of current and former JPMorgan executives before the Senate Permanent Subcommittee on Investigations over the "London Whale" hedge trading losses in 2012, the big event for big banks in the first quarter was the completion of the Federal Reserve's annual stress tests.

(Read More: 'London Whale' Not End of Big US Banks: Volcker)

The Federal Reserve has stuck with its preference of only permitting the largest banks to pay dividends of up to roughly 30 percent of earnings. For deployment of excess capital, the regulator prefers share buybacks, which offer greater flexibility since they can easily be curtailed at any time. This suits the big banks just fine, since large buybacks can reduce share counts sufficiently to bump up EPS estimates.

Regional Bank Earnings Previews

Here are third-quarter previews for the five largest U.S. regional banks by asset size:

U.S. Bancorp

Shares of U.S. Bancorp closed at $33.93 Thursday, returning 7 percent during the first quarter, following a 21 percent return during 2012. The shares trade for 2.7 times tangible book value, according to Thomson Reuters Bank Insight, and for 10.3 times the consensus 2014 earnings estimate of $3.28, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is $3.07.

The company on March 14 announced it would raise its quarterly dividend to 23 cents a share from 19.5 cents, and that it had received Federal Reserve approval for up to $2.25 billion in share repurchases through the first quarter of 2014. Based on Thursday's market close, the shares have dividend yield of 2.71 percent.

U.S. Bancorp will announce its first-quarter results on April 17. Analysts polled by Thomson Reuters expect the company to report earnings of 74 a share, declining from 75 cents in the fourth quarter, but increasing from 67 cents in the first quarter of 2012.

U.S. Bancorp's stock trades at the highest price-to-tangible-book multiple among the 24 components of the KBW Bank Index, although 14 of the index components trade at higher forward price-to-earnings multiples. The company's long-term earnings track record speaks for itself, with returns on average tangible common equity ranging from 14.18 percent to 23.09 percent over the past five years, according to Thomson Reuters Bank Insight. When considering that some of the other high performers posted negative returns on equity in 2009, USB's long-term performance is in a class by itself.

Deutsche Bank analyst Matt O'Connor rates U.S. Bancorp a "buy" and estimates first-quarter EPS of 74 cents, in line with the consensus. O'Connor said in a report on March 22, he expects the company's noninterest income "to be down 1.7 percent un-annualized q/q in 1Q primarily due to lower mortgage banking revenue (we estimate -9 percent) and seasonally lower deposit service charges/credit and debit card revenues."

PNC Financial Services Group

Shares of PNC Financial Services Group of Pittsburgh closed at $66.50 Thursday, returning 15 percent in the first quarter, following a 4 percent return during 2012. The shares trade for 1.3 times tangible book value and for 9.7 times the consensus 2014 EPS estimate of $6.83. The consensus 2013 EPS estimate is $6.53.

Based on a quarterly payout of 40 cents, the shares have a dividend yield of 2.41 percent. PNC on March 14 said its board of directors would "consider an increase" in the dividend at the next board meeting on April 4.

PNC will announce its first-quarter results on April 17. The consensus among analysts is for the company to report a profit of $1.56 a share, declining from $1.71 the previous quarter, but increasing from $1.44 a year earlier.

Oppenheimer analyst Terry McEvoy rates PNC "outperform," with a 12-to-18 month price target of $72, saying on March 14 the stress test results confirmed the company was "not too big, and not too small."

PNC's $3.6 billion acquisition of RBC Bank (USA) in March 2012 included $18.1 billion in deposits, $14.5 billion in loans and 424 branches in North Carolina, Florida, Alabama, Georgia, Virginia and South Carolina. When upgrading PNC to his current rating in September, McEvoy said the purchase of the RBC branches and the acquisition of the troubled National City Corp. in 2008, "were more than just financial engineering but also strategic moves that allowed PNC to enter new markets with a better product mix and sales culture."

McEvoy estimates that PNC will post first-quarter EPS of $1.62.

"We believe the valuation gap between other high-quality banks (i.e., USB and BBT) and PNC will narrow, especially as the market begins to appreciate the merits behind the RBC bank deal," he wrote.

BB&T

Shares of BB&T of Winston-Salem, N.C., closed at $31.39 Thursday, returning 9 percent during the first quarter, following a 19 percent return during 2012. The shares trade for twice tangible book value and for 10 times the consensus 2014 EPS estimate of $3.13. The consensus 2013 EPS estimate is $2.91.

Based on a quarterly payout of 23 cents, the shares have a dividend yield of 2.93 percent.

BB&T was dealt a sore blow on March 14, when the Federal Reserve announced it had rejected the bank's 2013 capital plan, based on "a qualitative assessment." Guggenheim Securities analyst Marty Mosby said in an interview on March 15 that "we believe BBT was penalized for requesting a dividend payout in excess of 30 percent of earnings. The Fed had warned banks that any requests that exceeded 30 percent of earnings on dividends or 100 percent of earnings in total capital distributions would receive increased scrutiny and they backed up this warning by making BBT this year's example."

"This was a surprise, since BBT passed the quantitative part of CCAR with a 7.8 percent post stress loss capital ratio and had sailed through previous reviews," Mosby said, adding that "BBT is not approved to execute any incremental capital distributions, including merger & acquisition requests," until it's revised capital plan is approved. BB&T will submit the revised plan by the end of the third quarter.

Despite the disappointment of having its capital plan rejected, BB&T has been one of the strongest among the large regional banks in the aftermath of the credit crisis. The company's return on tangible common equity has ranged from 8.22 percent to 20.45 percent over the past five years, according to Thomson Reuters Bank Insight.

BB&T will announce its first-quarter results on April 18, with analysts expecting the company to post EPS of 67 cents, declining from 71 cents in the fourth quarter, but increasing from 61 cents in the first quarter of 2012.

Excluding roughly 29 cents a share in "lumpy items," O'Connor estimates BB&T's first-quarter earnings will come to 70 cents a share.

"We expect core expenses to be down 3.6 percent with lower loan processing, professional services and foreclosed property expenses (we est -11 percent and -17 percent, and -12 percent, respectively)," O'Connor wrote. BB&T is also expected to see continued pressure on its net interest margin, in line with other regional banks, and O'Connor expects "reported noninterest income to be down 4.5 percent un-annualized q/q with seasonally lower insurance (we est -3.5 percent q/q), lower mortgage (we est -20 percent), seasonally lower service charge revenue, and other income flattish," according to the analyst's March 22 report.

SunTrust

Shares of SunTrust of Atlanta closed at $28.81 Thursday, returning 2 percent year-to-date, following a 62 percent return during 2012. The shares trade for 1.2 times tangible book value, and for 9.8 times the consensus 2014 EPS estimate of $2.93. The consensus 2013 EPS estimate is $2.69.

Following the completion of the stress tests, SunTrust announced it had received Federal Reserve approval to double its quarterly dividend to 10 cents and for share buybacks of up to $200 million through the first quarter of 2014. Based on the higher dividend payout, the shares not have a yield of 1.39 percent.

SunTrust will announce its first-quarter results on April 19. The consensus among analysts is for EPS of 62 cents, declining from 65 cents in the fourth quarter, but increasing from 46 cents in the first quarter of 2012.

KBW analyst Christopher Mutascio rates SunTrust "market perform," with a $30 price target, estimating the company will report first-quarter earnings of 60 cents. The analyst in a report on March 1 discussed the possible effect of slowing mortgage loan origination volume declining sale margins in the secondary market. Assumptions of an 8 percent decline in mortgage origination volume in the first quarter from the fourth quarter, with a 20 percent decline in gain-on-sale margins for newly originated mortgage loans, would lead to "a 1Q13 pro forma total mortgage banking income level of $238 million," declining from $286 million in the fourth quarter.

Mutascio's actual estimate for SunTrust's first-quarter mortgage banking income is $271 million, with the difference between his estimate and the pro forma number being four cents a share

"There are several moving parts to mortgage banking income (origination volumes, the gain-on-sale margin, servicing income, etc.) that reduce the confidence level in the resulting pro forma output," Mutascio wrote. "However, if our assumptions are close to being accurate, then there could be building pressure on the company to make good on its operating efficiency programs sooner than later."

Credit Suisse analyst Craig Siegenthaler on Tuesday downgraded Sun Trust to a neutral rating from an "outperform" rating, following a meeting with the bank's senior management. "We see risk to '13/'14 EPS due to (1) lower than expected expense mgmt. in '13/'14, and (2) the impact of swap portfolio runoff on [net interest income]," he wrote in a report on Tuesday.

On a more positive note, Siegenthaler added that "while we still think there is downside to STI's '14 estimates from gain on sale declines, we estimate this is expected from the buy-side in 1H13."

Siegenthaler lowered his 2013 EPS estimate for SunTrust to $2.47 from $2.56 and lowered his 2014 EPS estimate by a penny, to $2.84. The analyst's price target for SunTrust's shares is $28.00.

SunTrust's shares were down 2 percent in early trading, to $27.81.

Fifth Third Bancorp

Shares of Fifth Third Bancorp of Cincinnati closed at $16.31 Thursday, returning 8 percent during the first quarter, following a 23 percent return during 2012. The shares trade for 1.4 times tangible book value and for 9.7 times the consensus 2014 EPS estimate of $1.69. The consensus 2013 EPS estimate is $1.65.

Fifth Third on March 14 announced a "potential increase" in its quarterly dividend from 10 cents a share, with approval for the potential repurchase of up to $750 million in trust preferred securities. The company also received approval for the potential conversion of $398 million in convertible preferred shares to common shares. If the conversions are completed, the company has Federal Reserve approval for common share buybacks totaling up to $984 million.

Based on the current quarterly payout, the shares have a dividend yield of 2.45 percent.

Jefferies analyst Ken Usdin said in a report on March 15 that "we see FITB's announced capital plan as a modest positive. Potential upside to EPS is 3 percent at best and neutral at worst."

The company will report its first-quarter results on April 18, with the consensus estimate being a 39-cent profit, declining from 43 cents in the fourth quarter, and 45 cents in the first quarter of 2012.

O'Connor rates Fifth Third a "buy," and estimates the company will report a first-quarter profit of 40 cents, factoring in 2 cents from valuation adjustments in warrants the company holds to purchase shares of Vantiv (VNTV), as well as gains from a securitization of auto loans.

O'Connor expects Fifth Third's net interest margin "to decline modestly (possibly 4-5bps per quarter) through 2013."

For the first quarter, the analyst expects mortgage repurchase costs to decline by $29 million from an "elevated" fourth quarter.

By TheStreet.com's Philip van Doorn

Additional News: Bank of America in $165 Million Credit Union Settlement

Additional Views: 2013 a Transition for Banks: Expert

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Disclosures:

TheStreet does not permit any employees on its editorial staff to individually hold positions in individual stocks, though they are permitted to own stock in TheStreet.

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