NEW YORK ( TheStreet) -- Banks mostly beat expectations in the first quarter, but their earnings outlook remains cloudy given sluggish loan growth and low rates, Deutsche Bank analyst Matt O'Connor said in a note Tuesday.
"If rates don't rise and/or loan growth doesn't pick up, we believe banks may need to meaningfully lower their earnings run-rate expectations--either in 4Q13 or 1Q14," O'Connor wrote.
Banks managed to beat expectations through credit quality improvements but that was not sufficient to move the needle on earnings estimates. Analysts have mostly factored in lower credit costs in their forecasts.
Meanwhile, O'Connor expects revenues to improve in the second quarter but remain weak over the medium term, given low rates, pricing pressures and muted loan growth, in addition to the drag from regulatory pressures.As a result, the Deutsche analyst says investors should be selective in their approach to bank stocks and highlights Citigroup (C - Get Report), PNC Financial (PNC - Get Report) and US Bancorp (USB - Get Report) as top picks. "We prefer stocks that are late cycle recovery stories (such as C), have meaningful expense initiatives underway (C, PNC) and leverage to macro themes that we still expect to play out later this year/early 2014--such as slowing consumer deleveraging, housing improvement, and growth in consumer spending (USB)," he wrote. Citigroup beat expectations in the first quarter, with credit quality, capital and expenses control surprising to the upside. Deutsche expects the turnaround story to gain momentum, as the bank suffers less drag from its non-core arm, tightens expenses and utilizes more of its deferred tax assets that ties up capital. PNC Financial trades at a discount to peers on price-to-earnings, the analyst notes, and the bank's new management team "is increasingly focused on cutting costs". US Bancorp has "above average earnings growth" , making it another preferred pick. "We estimate EPS growth of two times the group average in 2015 vs 2012 (at ~30%) with the drivers likely to be continued market share gains in mortgage and a pickup in consumer and commercial spending (payments represent 15- 20% of revenue). Despite this, the stock trades only in line with peers on our 2013E and at a discount on our 2014/2015E," the analyst wrote. -- Written by Shanthi Bharatwaj in New York. >Contact by Email. Follow @shavenk