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TheStreet Open House

4 Large Bank Stock Picks From Deutsche Bank

Stocks in this article: BACCJPMFITBTCB

NEW YORK ( TheStreet) -- Large regional banks continue to outperform money center banks, despite the compelling stock price multiples for the largest bank holding companies.

Deutsche Bank analyst Matt O'Connor noted on Thursday that while the KBW Bank Index (I:BKX) "is down 13% from the March 26 high, this reflects a nearly 30% pullback on average in the Money Centers," including Bank of America (BAC), Citigroup (C) and JPMorgan Chase (JPM), while "using the S&P Commercial Bank Index (excludes Money Centers), the stocks are down a modest 3%--despite sharply lower interest rates, slowing economic growth and a much larger potential hit to capital from new proposed rules."

Summing up second-quarter results for the 17 large banks covered by his firm, O'Connor said that net interest margins (NIM) "were down just slightly on average and remain okay for now, but are not sustainable if rates remain at current levels." The net interest margin is a bank's average spread between its average yield on loans and investments and its average cost for deposits and borrowings. Over the past two years, banks have enjoyed lower funding costs as checking account balances grow, and higher-cost deposits reprice. But with short-term rates unable to head any lower, while long-term rates continue to decline and the Federal Reserve considers additional moves that could push long-term rates even further down, many banks are focusing on cutting expenses.

Bank of America, for example is pushing for $5 billion in annual cost savings through the end of 2014, through Phase 1 of its "Project New BAC" program, which focuses on the company's consumer business.

During the company's second-quarter conference call, CFO Bruce Thompson said that "we made progress on expenses, which declined $2.1 billion from the first quarter, of which approximately $900 million was due to the absence of annual retirement eligible stock-based compensation awards that impacted the first quarter."

Thompson said Bank of America was still on track to exceed the 20% of the $5 billion in annual cost savings by the end of 2012 from Phase 1 of the expense reduction program. The CFO said that he expected Phase 2 of Project New BAC -- focusing on wholesale and investment banking --would lead to expense reductions of "approximately $3 billion on an annualized basis, which would be fully phased-in by mid 2015," for total target annual expense reductions of $8 billion by the end of 2015.

O'Connor said that eight other large U.S. banks covered by Deutsche Bank "remain focused on reducing costs where possible, even if they don't have an official cost cutting initiative in place."

Another major theme for many of the large banks was continued strength in mortgage revenue, as the refinancing wave from the expanded Home Mortgage Refinance Program, or HARP 2.0, continues.

O'Connor said that "production volumes were mostly higher (driven by good refinance activity) and gain-on-sale margins remained strong," during the second quarter, and that he expects the low rates and HARP 2.0 "to continue to help mortgage activity in 2H12... however, gain on sale margins should eventually come down over time."

Here are O'Connor's two favorite picks among stocks of large U.S. banks, followed by his two buy-rated money center banks:

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