U.S. banks are trading at a 20% discount relative to the S&P 500 (INDEXSP:.INX), leaving more room for price growth as the economy improves, argue Citi analysts Keith Horowitz and Josh Levin, who estimate U.S. GDP growth will hit 2.7% this year and then ramp up to 3% or more in 2015.

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Regional banks offer poor risk/reward

With valuations at 13X 2014 estimated EPS, Horowitz and Levin don’t think that regional banks are attractive investments unless short-term interest rates increase faster than most people currently expect. “We don’t see much near-term upside in the regional banks,” they write. Their only regional bank buy recommendation is BB&T Corporation (NYSE:BBT), which they think is slightly underpriced due to a recent 10% pullback, while they recommend selling New York Community Bancorp, Inc. (NYSE:NYCB), which has changed its dividend policy and First Niagara Financial Group Inc. (NASDAQ:FNFG), whose stock they expect to fall as faith in the bank’s new CEO wanes.

There aren’t any obvious catalysts to drive growth in the near term, but a lot of the regulatory risk has already been priced in, and regulations are expected to have a bigger impact on the larger banks that represent more of a systemic risk. Even though we are still waiting on the SEC for the final terms of the Supplementary Leverage Ratio, the broad outlines of the SLR are known. The stricter Basel international standards may also be eased in 2014.

Trust banks to benefit from rate increase talk

“Although the Fed has gone out of its way to indicate that a hike in short term rates is likely a distant event, simply having the conversation benefits trust bank stocks more than taper conversation given their asset sensitive nature,” write Horowitz and Levin. “Additionally, trust bank stocks have historically rallied 12 to 14 months before the first Fed rate hike, and whether a rate hike comes in ’15 or ’16, trust bank stocks are within or not far from the next ‘rally window’.”

Among trust banks, they like State Street as the ‘purest play’ for a rerisking world because of its “focused, equity oriented business model,” but say that the The Bank of New York Mellon Corporation (NYSE:BK) could be a better long-term prospect.