NEW YORK (TheStreet) -- With regional banks facing great difficulty growing their earnings in the current low-rate environment, Goldman Sachs analyst Richard Ramsden favors three of the "big four" U.S. banks for investors.
Now that most of the large-cap banks have reported their third-quarter results, the trends include strong mortgage volume from the wave of refinancing, credit quality improvement with a recovery in housing values that becomes more clear with each economic report and, "better than expected capital markets revenue," according to Ramsden, who also said that there was another "reason for optimism in the pace of capital accretion" heading into the next round of Federal Reserve stress tests."
But Ramsden also said that the third-quarter results have "highlighted the biggest risk to bank earnings power: rapidly declining net interest margins." With the Federal Reserve keeping its target federal funds rate in a range of zero to 0.25% since the end of 2008, most banks have already seen most of the benefit in lower interest expense, while long-term rates have continued to decline. The Fed in September increased its monthly purchases of long-term mortgage-backed securities by $40 billion in an effort to hold long-term rates down.
Last month, Wells Fargo (WFC) telegraphed the margin pressure, when Tim Sloan said at a conference last month that the bank's net interest margin -- the difference between the average yield on loans and investments and the average cost for deposits and borrowings -- for the third quarter "could be similar to what we experienced in the third quarter of last year when our net interest margin was down 17 basis points."Wells Fargo's third-quarter net interest margin ended up at 3.66%, narrowing by 25 basis points from 3.91% the previous quarter, and 3.84%, a year earlier. Among regional banks, BB&T Corp. (BBT) of Winston-Salem, N.C., saw its third-quarter net interest margin held up nicely at 3.94%, declining only one basis point from the second quarter, however, the shares declined 8% over last Thursday and Friday, after the company estimated that its margin would "be in the mid-3.70s% range in 4Q12," because of lower rates being earned on new assets, higher long-term debit cost, and the runoff of assets covered by the Federal Deposit Insurance Corp. loss-sharing agreement, covering nonperforming assets acquired when BB&T purchased the failed Colonial Bank of Montgomery, Ala., in 2009. Comerica (CMA) of Dallas last Wednesday reported third-quarter earnings of $116 million, or 61 cents a share, missing the consensus estimate of a 65-cent profit, among analysts polled by Thomson Reuters. While the earnings miss was driven by a $14 million decline in noninterest income and $16 million increase in noninterest expense from the second quarter, Comerica's net interest income declined to $427 million, from $435 million the previous quarter, as the company's net interest margin narrowed by 14 basis points sequentially to 2.96%. FBR analyst Paul Miller -- who rates Comerica "Market Perform," with a $34 price target -- on Monday said that "given its asset sensitivity and leverage to floating rate [commercial and industrial] lending, Comerica will likely struggle to grow earnings in the current rate environment." Ramsden on Monday said that "the rate of asset yield pressure is worse than expected and funding benefits are only finite. Our revised estimates imply that with 18bp of NIM pressure through 4Q13, banks face an 11% EPS headwind (all else equal)," and because "all banks will be negatively impacted, we prefer large-cap banks with other levers for EPS growth." "Given acute NIM pressure and only modest asset growth opportunities," Ramsden said "we favor large-cap banks given 1) less reliance on spread income, and 2) greater offsets from expense / capital leverage," and that he "continued to favor" JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo, and that although Bank of America (BAC) and Morgan Stanley (MS) "meet the EPS leverage requirements, valuation appears reflective, in our view." Considering the company's lingering material and headline risk from mortgage putback demands, springing mainly from its disastrous purchase of Countrywide Financial in 2008, it may be a surprise to see Bank of America's shares as "expensive," to forward earnings, but the shares trade at the highest forward P/E among the big four U.S. banks. Bank of America's shares closed at $9.55 Monday, returning 72% year-to-date, following a 58% decline during 2011. In one respect, the shares remain heavily discounted, trading for just 0.7 times their reported Sept. 30 tangible book value of $13.48, but the shares are relatively expensive, at 10 times the consensus earnings estimate of 95 cents a share, among analysts polled by Thomson Reuters. Bank of America reported a small third-quarter profit of $340 million, or zero cents per share, with earnings hit by $1.6 billion in litigation expenses, from the company's settlement of a class action lawsuit related to its acquisition of Merrill Lynch in 2009. Ramsden has a neutral rating on Bank of America, with a $10 price target, estimating the company will earn 95 cents a share in 2013 and $1.20 a share in 2014. Here's a quick look at the remaining members of the big four banking club that Ramsden recommends, ranked by ascending upside based on the analyst's price targets:
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