A new Industry Report from equity research firm Sterne Agee suggests that that investors are not fully aware of the acceleration in earnings growth that big banks will enjoy in 2015 nor that the quality of earnings across the industry continues to steadily improve. In the September 17th report, SA analysts Terry McEvoy and colleagues recommend the sector and have a Buy rating on four super regional bank stocks.

The SA analysts summarize their perspective in the overview of the report. “A part of this [bullish super regional banks] thesis was centered on the prospects of a higher Federal Funds rate in 4Q15 and beyond along with improving and more broad-based loan growth. For those looking to get greater exposure to the super regionals our recommendations are FITB, STI, CMA and PNC”

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Regional Banks EPS growth

Super regional banks earnings estimate

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McEvoy et al. are projecting an average EPS growth of 7% in 2015 and 16% in 2016 for the super regional banks sector. The analysts also note that for banks in which they hold an above-consensus view, their 2016 estimates are 2-13% above consensus (3% on average), relating to their more favorable view on net interest income levels and expense trends.

Interest rate assumptions

At the FOMC earlier this week, the Fed said it planned to maintain interest rates near zero for a “considerable time,” and it also that more FOMC participants perceive the appropriate timing of policy firming as 2015 (14 of 17). Of note, the median projection for Fed Funds rates was 1.375% by the end of 2015 and 2.875% at year-end 2016. These projections were 1.125% and 2.50%, respectively, two months ago.

regional banks median

When calculating their estimates, the Sterne Agee analysts assume the Fed starts increasing the Fed Funds rate in the fourth quarter of 2015. They anticipate a 25 bps average increase in 4Q15 and another 100 bps throughout 2016.

Rationale for valuation

Regional Banks Asset sensitivity

McEvoy and colleagues base their valuations on their positive fundamental outlook for the sector. They project modest multiple expansion as well as a significant acceleration in earnings growth as interest rates rise to drive above average super regional bank stock performance over the next year or two. The report also highlights that from 2004 to mid-2008 (financial crisis) super regional banks typically traded at 12x one-year-out EPS estimates, but today the sector average is closer to 11x.

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