Sterne Agee analysts Todd L. Hagerman and Robert Greene cite operating efficiencies, lower legal and environment related costs, marginal loan growth and increased capital returns as the factors that could drive improved earnings growth at the large regional banks/broker.

“Despite significant multiple expansion over the past year, we believe the large broker/ regional banks offer the best risk/reward. However, as we enter ’14, we see few catalysts to drive sector performance significantly higher as earnings meaningfully slow,” say the analysts in their research note on banking of January 14, 2014.

The solid rally by regional banks

A reference to the following chart of the SPDR KBW Regional Banking (ETF) (NYSEARCA:KRE) shows the huge rally that regional banks already have under their belt:

1-rally Regional Banks

Indeed, the ETF has already made up most of the price damage that occurred since the pre-crisis levels prior to 2008.

Sterne Agee’s picks

Sterne Agee has Buy ratings on the following banks:

  • Popular Inc (NASDAQ:BPOP) with a price target of $28.75: Cheaply priced and several drivers such as stability in the Puerto Rico economy, emergence from TARP and better profitability.
  • JPMorgan Chase & Co. (NYSE:JPM) with a price target of $57.74: The worst of the legal costs nightmare may be over; high return on tangible common equity; double digit growth in tangible book value.
  • M&T Bank Corporation (NYSE:MTB) with a price target of $114.80: very profitable and consistent earner; good loan growth, stable core margin.

More on regional banks – impending M&A

A KPMG survey says almost 65% of community bank executives said they expected their bank to likely participate in an M&A transaction in a year.

Accordingly, in 2014, regional banks could be fertile grounds for deal-making – more so because compliance and regulatory costs are taking a heavy toll and organic growth is still difficult. Banks post-consolidation would enjoy greater market share and better earnings.