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Bank Stress Test Losers: How to Trade Them

In the aftermath of the Federal Reserve's latest round of stress tests on 19 large financial holding companies, there are two clear losers, as well as several banks perceived by analysts as not taking full advantage of regulatory developments.

Bank of America branch, New York City.
Oliver Quillia for cnbc.com
Bank of America branch, New York City.

As we have seen over the past week for Bank of America and Capital One , the headlines can be quite painful for day traders, but for long-term investors picking large bank stocks, the piling on could be a buying opportunity as the banks dance around the Fed's rejection of their capital plans.

Following the completion of the Fed's Comprehensive Capital Analysis and Review of large bank holding companies, SunTrust and KeyCorp announced plans to raise common equity to repay government bailout funds received through the Troubled Assets Relief Program, or TARP.

Regions Financial decided to hold off, saying its "position of repaying the government's TARP investment in a prudent manner, on shareholder-friendly terms, remains unchanged."

Other holding companies including JPMorgan Chase , Citigroup , Wells Fargo , BB&T , Bank of New York Mellon , State Street increased their quarterly dividend payouts, with some also announcing new or increased authorizations for buybacks of common shares.

PNC Financial lagged the others in announcing that, while the Fed had not objected to the company's plan to increase its dividend in the second quarter and plans to resume buying back shares, the company's board of directors wouldn't consider a dividend increase until its next regularly scheduled board of directors meeting on April 7. One analyst told TheStreet that PNC had mishandled the stress test situation by not convening a board meeting earlier.

Stifel Nicolaus analyst Christopher Mutascio said that "Bank of America would be the big loser," and assumed that the Fed's rejection of its capital plan "has a lot to do with the mortgage put-back risk. Perhaps the Fed is not comfortable with the amount that BofA will have to repurchase."

Mutascio also indicted that there may have been some disappointments with dividend increases by Wells Fargo , which increased its quarterly payout to 12 cents from 5 cents, and U.S. Bancorp (USB), which increased its payout to 12.5 cents from 5 cents.

The following is a quick look at short-term and long-term investment prospects for five losers and laggards from the Federal Reserve's stress tests:

Bank of America

Bank of America's shares declined 5% from their close at $13.98 on March 17, through Friday's close at $13.34.

The company announced on Wednesday that while Fed had rejected the company's plan to begin returning capital to shareholders, the bank would soon submit a revised plan in the second half of this year.

FBR Capital Markets analyst Paul Miller on Thursday downgraded the shares to a neutral rating of "market perform" from "outperform." Then again, Miller said that if the company is successful in competing for investment banking business and housing begins to recover, "the sell-off in shares creates an oversold situation as the stock is trading at a discount to peers on earnings."

The Short-Term View

The piling on continues for Bank of America, with endless coverage of the company's risk from lawsuits and claims from institutional investors seeking to have the company buy back mortgage paper originally issued by Countrywide, which BAC acquired in July 2008.

Further grist for the mill was provided by a Financial Times report on Friday, saying that bank regulators had asked large mortgage servicers — including Bank of America — to pay mortgage borrowers with homes in foreclosure as much as $21,000 apiece to leave their homes. This idea comes under the beautifully named "cash for keys" program, and is just the sort of thing that will keep hammering the stock over the short haul.

It's quite clear that the political leadership of the bank regulators really has it in for the largest banks and their shareholders, but the pendulum always swings.

The Long-Term View

Bank of America was featured as one of TheStreet's 10 Liquid Bank Stocks with Most Price Upside, based on last Wednesday's market and analyst data provided by SNL Financial. Based on that data, the forward price-to-earnings ratio was a historically low 75, based on the consensus earnings estimate among analysts polled by Thomson Reuters.

Out of 24 sell-side analysts covering Bank of America, 14 recommend buying the shares, while the other 10 have neutral ratings.

Following the company's announcement on Wednesday, Anthony Polini of Raymond James reiterated his "strong buy" rating for Bank of America, saying the price weakness presented "an excellent buying opportunity," and that the shares offered "tremendous upside potential" of over 70% based on the analyst's price target of $24.

Another long-term perspective was provided by Glenn Schorr of Nomura Research, who said in a report Friday following a meeting with Jonathan Moulds — Bank of America's president for Europe, the Middle East, Africa and Asia — that the company "remains a good long-term story with clear value," although "2011 is likely to remain choppy." Keeping in mind that analysts' ratings and price targets have a relatively short-term outlook of twelve months, Schorr has a neutral rating on the shares, with a $15 price target.

Capital One

Fred Cannon of KBW said that Capital One "would appear to be a loser," which the analyst described as "the biggest mystery," as the company "didn't say anything or talk about (its) capital plan at all."

The shares rose 1% from a close of $50.78 on March 17 to $52.23 on Friday.

After reports that the Federal Reserve had objected to the company's plan to begin returning capital to investors through dividend increases or buybacks, Brian Foran of Nomura reiterated his buy rating on the company's shares with a $58 price target, saying the Fed had a negative view despite Capital One's "high and building capital.

The Short-Term View

Capital One's shares have risen 23% this year through Friday's close, and every piece of good news on the unemployment front should help the shares. Another catalyst is steady improvement in delinquencies reported in monthly credit card master trust filings.

According to data supplied by SNL Financial, Capital One reported that its serviced credit card delinquencies of 30 days or more had improved to 3.98% in February from 4.11% the previous month. In Comparison, Citigroup's delinquency for February - reported for balances past due 35 or more days -- was 4.34%, improving slightly from 4.35% in January. JPMorgan's credit card delinquency rate for February was 3.29%, improving from 3.39% the previous month.

For Capital One, the annualized credit card loss rate was 5.18% in February, and among the seven major card lenders included in SNL's report, was only bested by American Express (AXP), which had a loss rate of 4.24%.

The Long-Term View

Out of 22 analysts covering Capital One, eight have buy ratings, 12 have neutral ratings and two analysts recommend selling the shares.

On Thursday, Chris Brendler of Stifel Nicolaus maintained his buy rating on Capital One and increased his price target to $60 from $55, saying that pressure on the shares from the "Fed's view of its capital situation," has made the stock "more compelling."

Brendler also said that the Federal Reserve's objection to Capital One's plan t return capital to shareholders was "only somewhat of a surprise and is not a significant concern." Finally, Brendler said his firm believes "COF will not be forced to raise additional capital. If we are wrong, the stock will likely underperform."

Regions Financial

While analysts don't consider Regions Financial to be a loser following the Federal Reserve's stress tests, since few expected the company to quickly repay TARP, the company is certainly a laggard, as the other two large publicly traded regional banks owing bailout funds to the government -- SunTrust and KeyCorp -- immediately announced plans on March 18 to repay the government and quickly completed common equity raises.

Still, the company's shares declined 2% from a closing price of $7.35 on March 17 to $7.18 on Friday.

The Short-Term View

For Regions, investors will be looking closely at first-quarter results, keen on further improvements following a return to profitability in the fourth quarter, also looking at a second consecutive quarter of improved credit quality ratios.

The Long-Term View

Out of 20 analysts covering Regions Financial, 17 have neutral ratings, while three analysts recommend selling the shares. For investors considering jumping in, a "wait and see" attitude is probably best, with $3.5 billion in TARP money to repaid, and a dilutive capital raise likely later this year.

PNC Financial

PNC Financial can also be perceived as a laggard, since the company's board of directors won't even meet to consider a dividend increase until its regularly scheduled meeting on April 7. In terms of playing the investor relations game, the other major players saw fight to convene board meetings earlier and make announcements quickly following the completion of the stress tests.

Fred Cannon said "PNC has been pretty clear as a matter of time, waiting for board meeting," adding that "it was a race to the wire, so right after the Fed put their release out, several banks just pushed out the press releases."

The shares closed at $61.77 Friday, declining slightly from their close on March 17.

The Short-Term View

Among the "stress test 19," PNC's 2010 earnings performance measured up well, with an operating return on average assets (ROA) of 1.14%, tied with U.S. Bancorp, and only bested by American Express, with a 2010 ROA of 2.91%, and Capital One, at 1.52%.

PNC is considered a quality name by analysts, remaining profitable through the credit crisis, except for a loss during the fourth quarter of 2008. One key item of concern to investors when the company reports its first-quarter results will be the net interest margin, which is the difference between a bank's annualized average yield on loans and investments and its average cost for deposits and borrowings. The margin declined to 3.94% in the fourth quarter, from 4.14% a year earlier.

Richard Bove of Rochdale Securities said last week that PNC might have a surprisingly good first quarter, with rising loan volume.

Christopher Mutascio said that in the second quarter, PNC's quarterly dividend "go to about 30 cents," from its current payout of 10 cents a share.

The Long-Term View

Analysts love PNC. Out of 26 analysts covering the company, 22 rate the shares a buy, while four have neutral ratings. The mean price target among analysts polled by Thomson Reuters is $72.87, implying 19% upside for the shares.

The shares are trading for less than 10 times the consensus 2012 earnings estimate of $6.38 a share.

Following the company's fourth-quarter earnings announcement in January, William Wallace of Howe Barnes Hoefer & Arnett reiterated his buy rating and $75 price target for PNC's shares, "predicated on PNC's ability to deploy excess capital through dividend hikes, share buybacks, loan growth, and consolidation opportunities that will drive its [return on tangible equity] well above peers."

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Disclosures:

TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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Disclosures:

TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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