Citigroup Cuts Regional Banks
“Most regional bank stocks don’t offer much upside given their current valuations,” according to Citigroup analyst Keith Horowitz.
Continuing what now seems to be an annual pattern for the banking space, with a strong first quarter, followed by a weakening outlook for the rest of the year, Citigroup on Friday cut its 2013 earnings estimates for 13 out of 16 large regional banks in the firm’s coverage universe, while lowering price targets for 10 of the companies.
In light of the “flattening of the yield curve that has taken place since (the first quarter of 2012) earnings season,” — with short-term rates unable to go much lower, while the yield on 10-year U.S. Treasurys slipped below 1.5 percent last week — Citigroup said that “the primary driver of the lower estimates is, not surprisingly, [net interest margin, or NIM] compression, particularly from the substantially lower reinvestment rates banks will face as legacy loans and securities are repaid or mature.”
A bank’s net interest margin is its average yield on loans and investments, less its average cost for deposits and wholesale borrowings.
Horowitz said that bank treasurers attending Citigroup’s annual conference for treasurers two months ago “expected the 10-year Treasury to be in the 2 percent to 2.10 percent range by year-end — almost 50 (basis points) higher than the current yield,” and that the “mismatch between expectations and reality suggests that bank treasurers have their work cut out for them.”
Citigroup sees a “slow burn” for the regional banks, as “lower expectations for long rates only fully manifests itself over time as it lowers expected reinvestment rates, steadily reducing expected yields on fixed rate assets as loans and securities [re-price].” If rates “were to stay flat through 2014, we estimate NIMs could fall by a further ~10 (basis points),” said Horowitz.
Most regional banks continue to see very strong deposit growth, and, of course, seek to avoid being locked into very long terms for their new securities investments, because of the low rates. Horowitz said that yields on mortgage-backed securities have generally “shrunk less than the recent move seen in Treasurys,” because “an investor is much less willing to pay-up significantly above par for MBS pass throughs given risk the bond will be called back in a year or two at par.”
According to Citigroup, the average yield for a select group of Fannie Mae and Freddie Mac MBS with “effective durations of 1 to 3 years [that] are likely in the zone of plain vanilla options for bank treasurers,” declined to 2.06 percent as of June 6, from 2.42 percent at the end of March.
On the bright side, the Federal Reserve’s new capital rules excluding trust preferred shares from Tier 1 capital will enable banks to “activate a contractual clause allowing them to redeem TruPS at par,” according to Horowitz, allowing the banks “to redeem relatively expensive debt, which has an average cost of 7.4 percent for the group” or regional banks covered by Citi, “with some securities carrying a coupon in excess of 10 percent.”
Horowitz said that “redeeming TruPS will create a near term NIM lever for the group as they are able to replace the TruPS with alternative capital at a minimum, or preferably using debt or excess cash should create a modest tailwind near-term.”
The following are the three regional bank holding companies within the firm’s coverage universe facing the “most significant” impact from compressed net interest margins through 2014, according to Citigroup’s “flat rate scenario,” followed by the three for which “flat rates have the least incremental impact.”
SVB Financial Group
Shares of SVB Financial Group of Sana Clara, Calif., closed at $56.65 Thursday, returning 19 percent year-to-date, following a 10 percent decline during 2011.
The shares trade for 1.1 times tangible book value, according to Thomson Reuters Bank Insight, and for 15 times the consensus 2013 earnings estimate of $3.78 a share, among analysts polled by Thomson Reuters. The consensus 2012 earnings per share estimate is $3.48.
Citigroup Analyst Josh Levin has a “neutral” rating for SVB Financial, and on Friday lowered his price target for the shares to $60, while leaving his 2012 earnings per share estimate unchanged at $3.45, and lowering his 2013 earnings per share estimate by 15 cents to $4.05, and his 2014 estimate by 40 cents, to $4.70.
Levin estimates that SVB Financial’s net interest margin will increase from 3.27 percent this year to 3.36 percent in 2013 and 3.57 percent in 2014. However, under Citigroup’s “flat rate scenario,” with interest rates remaining second-quarter 2012 levels through 2014, Levin estimates that SVB Financial’s net interest margin will increase from 3.26 percent this year to 3.28 percent in 2013 and 3.32 percent in 2014.
The analyst said that “SIVB has one of the most differentiated business models in banking,” focusing on lending to innovative “companies in fields such as software, hardware and life sciences,” and “given that these industries are enjoying growth well above the broader economy, SIVB is enjoying growth well above other regional banks.”
“Despite the many positive attributes of the SIVB story,” Levin said, “we think it is trading close to fairly valued.”
Shares of Comerica of Dallas closed at $28.94 Thursday, returning 12.5 percent year-to-date, after dropping 38 percent during 2011. Based on a quarterly payout of 15 cents, the shares have a dividend yield of 2.07 percent.
Comerica’s shares trade for 0.9 times tangible book value, and for 11 times the consensus 2013 earnings per share estimate of $2.71. The consensus 2012 earnings per share estimate is $2.51.
Levin rates Comerica a “sell,” and lowered his price target for the shares to $28 from $29, while leaving his 2012 earnings per share estimate unchanged at $2.45 and cutting his 2013 estimate by a nickel to $2.55 and his 2014 estimate by 15 cents to $2.80.
The analyst estimates that Comerica’s net interest margin will be 3.11 percent in 2012 and 2013, rising to 3.15 percent in 2014. Under the “flat rate scenario,” Levin estimates that the company’s margin would decline from 3.09 percent in 2012 to 3.03 percent in 2013 and 3.02 percent in 2014.
Levin calls Comerica a “well-run company with a highly talented and capable management team,” saying that the bank’s focus on commercial and industrial lending “exposes it to that segment of the loan market which we believe will experience the highest growth over the next one to two years.” But Citigroup believes “the stock is overvalued at its current valuation given that we project that CMA will have the greatest gap in our coverage universe between its [return on equity, or ROE] and its cost of equity over the next two years.”
Shares of Zions Bancorporation of Salt Lake City closed at $18.31 Thursday, returning 13 percent year-to-date, after a 33 percent decline during 2011.
The shares trade for 0.9 times tangible book value, and for 10 times the consensus 2013 earnings per share estimate of $1.85. The consensus 2012 earnings per share estimate is $1.28.
Levin has a “neutral” rating on Zions Bancorporation and on Friday lowered his price target for the shares to $20 from $22, while leaving his 2012 EPS estimate of $1.30 unchanged, and lowering his 2013 estimate by five cents to $$1.75, and cutting his 2014 estimate by 15 cents to $2.25.
The analyst estimates that the company’s net interest margin will decline from 3.67 percent this year to 3.62 percent in 2013, and then rise to 3.78 percent in 2014. Under Citi’s “flat rate scenario,” Levin estimates that Zions would see a 2012 net interest margin of 3.66 percent, followed by margins of 3.57 percent in 2013 and 3.64 percent in 2014.
Levin says that with “an unusual corporate structure in that it operates eight different banks across the Western and Southwestern parts of the country,” Zions “is one of the more complicated stories in our regional bank coverage universe," with a complicated corporate structure, a messy capital structure, and a portfolio of [consolidated debt obligations].”
The analyst said that “although we believe there are sources of upside to its current valuation, we think this complexity is weighing on ZION’s valuation.”
Shares of KeyCorp of Cleveland closed at $7.15 Thursday, declining 6 percent year-to-date, following a 12 percent decline during 2011. Based on a five-cent quarterly payout, the shares have a dividend yield of 2.80 percent.
The shares trade for 0.8 times tangible book value, and for nine times the consensus 2013 earnings per share estimate of 82 cents. The consensus 2012 earnings per share estimate is 77 cents.
Levin rates KeyCorp a “buy,” although the analyst lowered his price target for the shares on Friday to $8.50 from $10, while leaving his 2012 earnings per share estimate unchanged at 70 cents and cutting his 2013 estimate by five cents to 80 cents, and his 2014 estimate by five cents to 85 cents.
The analyst estimates that KeyCorp’s 2012 net interest margin will be 3.17 percent, declining to 3.13 percent in 2013 and 3.08 percent in 2014. Under the “flat rate scenario,” the 2012 margin estimate is unchanged at 3.17 percent, followed by 3.12 percent in 2013 and 3.05 percent in 2014.
Levin said that “despite the lack of catalysts, we think the stock is cheap,” trading at “an ~15 percent discount to its peers on a [price to tangible book value] basis,” and that given the discount to book value and a “Tier 1 Capital ratio of ~11.3 percent is above the peer group median of ~10.8 percent, we think KEY offers more downside protection than most of its peers in a market sell-off.”
The analyst added that “longer term, how KEY deploys that capital will be a bigger driver of the stock's valuation.”
Huntington Bancshares of Columbus, Ohio, closed at $6.10 Thursday, returning 12 percent year-to-date, following last year’s 19 percent decline. Based on a quarterly payout of four cents, the shares have a dividend yield of 2.62 percent.
The shares trade for 1.2 times tangible book value, and for nine times the consensus 2013 earnings per share estimate of 66 cents. The consensus 2012 earnings per share estimate is 63 cents.
Levin has a “neutral” rating on Huntington Bancshares, with a target price of $6.50. The analyst on Friday left his 2012 earnings per share estimate of 63 cents unchanged, while lowering his 2013 earnings per share estimate by three cents to 65 cents, and lowering his 2014 estimate by six cents, to 78 cents.
Citigroup estimates that Huntington’s net interest margin will decline from 3.31 percent this year to 3.21 percent in 2013 and 2014. Under the “flat rate scenario,” the only change to the margin estimates is a slight decline in the 2014 net interest margin estimate to 3.17 percent.
Levin said that with “HBAN’s long-term focus, we think in the near-term this stock will largely be driven by macro factors and less by company-specific factors,” and that “given its current price and the lack of identifiable company-specific catalysts, we think HBAN is trading close to fair value.”
Shares of Wells Fargo closed at $31.18 Thursday, returning 15 percent year-to-date, following a 10 percent decline in 2011. With a 22 percent quarterly payout, the shares have a dividend yield of 2.82 percent.
The shares trade for 1.9 times tangible book value, and for nine times the consensus 2013 earnings per share estimate of $3.68. The consensus 2012 earnings per share estimate is $3.28.
Citigroup analyst Keith Horowitz has a “neutral” rating on Wells Fargo, and on Friday lowered his price target for the shares by a dollar to $34, while leaving his 2012 earnings per share estimate of $3.20 unchanged, and lowering his 2013 estimate by 10 cents to $3.45, and his 2014 estimate by 25 cents to $3.65.
Citi estimates that Wells Fargo’s net interest margin will decline from 3.86 percent this year to 3.79 percent in 2013 and 3.73 percent. Under the “flat rate scenario,” the margin estimates are unchanged, except for slight decline in the 2014 margin estimate, to $3.69.
Horowitz called Wells Fargo “one of the better managed companies in the bank sector” and said “the company should benefit from its strong mortgage origination and retail brokerage franchises, as well as see further expense gains from optimizing the Wachovia franchise.”
“Nevertheless,” the analyst said, “we remain on the sidelines with the stock given expected challenges to net interest margins in the anticipated prolonged low rate environment.”
Over the long term, Horowitz expects Wells Fargo’s return on tangible equity to be “in the 18 percent range, so we see strong long-term value, but view current valuation as fair, with WFC trading at approximately 1.8x tangible book vs. large peers at 1.6x.”
—By TheStreet.com’s Philip van Doorn
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