NEW YORK (TheStreet) -- Regional banks are relying on expense cuts to meet earnings estimates, which "makes it difficult to argue for multiple expansion across the sector," according to Oppenheimer analyst Terry McEvoy.
The clear trend for regional banks in the first quarter was significant cuts in credit and overhead expenses offsetting plenty of revenue pressure, including narrowing net interest margins, a decline in mortgage loan applications and lower gains on the sale of mortgage loans. This enabled most of the regionals to meet consensus earnings estimates, but also signaled pressure for bank stocks through the rest of 2013.
Earnings estimates are very important to investors, as revisions to the estimates can drive stock prices, especially if there is a trend of similar revisions among many analysts. There has been an upward trend for several years for earnings estimates, as analysts have correctly anticipated a decline in credit-related expenses and the release of loan loss reserves, as the industry recovers from the real estate crisis.
But that trend appears to be over, at least for now."Consensus estimates did not change on average post 1Q13 earnings," McEvoy wrote in note to clients late on Monday, "however, we now see lower-quality earnings with reduced revenue forecast offset by the new lower run-rate of estimates."
For the largest 100 regional and small banks by total assets, total revenue declined by $1.0 billion in the first quarter from the fourth quarter, with expenses declining by $1.5 billion, according to McEvoy. The decline in revenue was "split evenly between net interest and fee income as bank and mortgage spreads compressed in the quarter," he wrote. Net interest margins continue to be pressured, with the Federal Reserve keeping the short-term federal funds rate in a range of zero to 0.25% since late 2008, while the central bank has recently been making monthly purchases of $85 billion in long-term securities, in an effort to hold long-term rates down. So most banks have already enjoyed most of the benefit from declining funding costs, while their assets continue to reprice at lower rates. Jefferies analyst Ken Usdin made similar comments in a report on Monday, saying that 2013 and 2014 earnings estimates "held up, but in a low quality way. [Revenue] forecasts were revised lower in most cases and better credit and expenses made up the difference." Usdin added that with regional bank stocks on average trading for 12.7 times 2014 earnings estimates, "the group is reasonably valued, but it is tough to argue that [estimates] have floored, given lackluster revenue trends." In a report on Tuesday, Citigroup analyst Josh Levin wrote "the stability in headline consensus EPS is deceptive," adding his team's research "suggests that investors are paying roughly the same multiple for lower quality earnings streams which have greater likelihoods of downward revisions than they did previously."
Despite the depressing focus on cost-cutting rather than revenue growth, McEvoy said Oppenheimer's "top picks" among bank stocks "remain those banks with additional opportunities for expense and/or deposit cost reductions . . . and ones where believe consensus is too low." Here are the three top Oppenheimer regional bank stock picks rated "outperform," in order of ascending upside to the firm's price targets:
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