Regional Banks Set To Attract Investors’ Fancy: Sterne

By Mani
Updated on

Investor sentiment towards the regional banks, particularly those with a longer-time horizon, will turn more positive in 2014 and into 2015, note Sterne Agee analysts Terry McEvoy and team .

The Sterne Agee analysts, in their industry report dated May 29,  point out that out of 10 regional bank stocks in their coverage universe, none have an Underperform rating.

Three regional banks have big upside potential

The following are the ten regional banks on the Sterne Agee analysts’ radar.

The analysts assume short-term rates begin to increase in the fourth quarter of 2015, indicating that starting 2H14, it would be appropriate to aggressively own the sector based on the fundamental outlook.

The analysts believe thanks to the U.S. economy regaining its path to expansion following a long and cold winter, investor sentiment towards the regional banks, particularly those with a longer-term time horizon, will turn more positive in 2014 and into 2015.

Resurgence in CRE lending

As can be deduced from the following graph, the analysts point out that over the past few quarters, a resurgence in commercial real estate lending has been witnessed:

Resurgence in CRE lending

Citing the examples of BB&T and Associated Banc, the analysts point out that as more loans are re-priced lower, the impact on the NIM would be obvious, other things remaining unchanged.

Turning their focus to net interest margin trends, the analysts point out that the cost of funds declined just 1 bps last quarter for the regional banks, on median, to just 35 bps. The analysts note behind the decline in net interest margins over the past couple quarters is the ongoing buildup of investment securities at the regional banks in anticipation of new liquidity requirements. The following graph captures the trends in long yields, securities yields and cost of funds:

Yield and cost of funds trends

The Sterne Agee analysts also note regulators are digging deeper into leveraged loans. As can be deduced from the following graph, the largest increase in terms of industry was consumer and communications. However, the analysts point out that many of the regional banks under their coverage focus on the energy sector, which only witnessed modest growth in 2013:

Leveraged loans by industry

Turning their focus to earnings growth, McEvoy et al. note looking out into 2015, they anticipate earnings growth to pick-up to roughly 10% as overall loan growth increases and higher short-rates starting in the fourth quarter. For 2016, the analysts anticipate EPS growth accelerating further to 15% largely driven by substantial margin widening from their modeled 100 bps average rise in rates. Future earnings growth for the two years are captured in the graphs below:

EPS growth estimates

The following table highlights both the consensus and Sterne Agee analysts’ estimates of earnings at the regional banks:

Estimates for regional banks

The analysts expect to see the highest potential upside over the next 12 months at Fifth Third,  SunTrust Banks, Inc. (NYSE:STI) and PNC Financial Services Group Inc (NYSE:PNC), while over the next 12-18 months, they anticipate Comerica will also be one of the top-performing regional bank stocks. Accordingly the analysts have assigned a Buy rating on the four regional banks.

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