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10 Cheapest Bank Stocks to Forward Earnings (Update 3)

Updated from 12:58 p.m. ET with confirmation of Bank of America's settlement with MBIA.

NEW YORK (TheStreet) -- There are still bargains out there in Bank Stock Land.

Even though the KBW Bank Index (I:BKX) is up 11% this year through Friday's close, following last year's 30% return, there are still 21 active bank stocks trading below 10 times consensus 2014 earnings estimates.

In an interview last week, FIG Partners analyst John Rodis said that at the end of April, the 17 small and midcap banks he covers were trading for an average of 13.8 times 2014 earnings estimates. This is a much higher average multiple than that of banks with over $50 billion in total assets, which traded as a group for 10.1 times forward earnings estimates, according to FIG Partners data.

Forward P/E multiples are much lower for the big banks because of a difficult growth environment, pressure on net interest margins, and because of investor mistrust in the wake of the credit crisis and industry bailout. The big banks have been focused on cutting expenses in order to hit their numbers.

Using data supplied by the crack team of analysts at Thomson Reuters Bank Insight, we have identified the 10 actively traded bank stocks with the lowest forward price-to-earnings ratios. For similar lists in previous articles we have defined "actively traded" as stocks with average daily trading volume of 50,000 shares. This time we have lowered that number to 20,000, to bring more variety to the list.

Even though most banks have repaid government bailout funds received through the Troubled Assets Relief Program, or TARP, with the program earning a profit for taxpayers according to the U.S. Treasury, regulatory and political scrutiny of the nation's largest banks is continuing to hold back their stock valuations. The most recent political move against the big banks is the Terminating Bailouts for Taxpayer Fairness Act. The bill -- sponsored by Senators Sherrod Brown (D., Ohio) and David Vitter (R., La.) -- would greatly raise the largest banks' capital requirements while having the U.S. "walk away" from the Basel III agreement and risk-based capital rules. Under Brown-Vitter, the banks' capital requirements for the safest investments, including cash and U. S. Treasury obligations, would be the same as for junk bonds.

There's little chance of the Brown-Vitter bill passing, but the bill reflects the continued distrust of banks in Washington, along with the opportunistic bashing of large banks which is to be expected in light of the real estate crisis and the bailout. Then again, we are nearly three years into the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which has done a great deal to strengthen the oversight of the big banks, including annual stress tests by the Federal Reserve. All of the large banks have greatly strengthened their capital levels over the past several years.

The fallout against JPMorgan Chase (JPM) over last year's "London Whale" hedge trading loss continues, with CEO James Dimon being told by regulators from the Office of the Comptroller of the Currency and the Federal Reserve last month that they didn't trust the bank's management, according to reports in the Wall Street Journal. Dimon is set to hold a meeting with a large group of OCC examiners. Dimon also faces a vote at the company's annual shareholders meeting on May 21, to give up his position as chairman of the board of directors.

Rafferty Capital Markets analyst Richard Bove on Monday made a strong case for allowing Dimon to keep both the CEO and chairman titles. In a note to clients, Bove wrote that "Jamie Dimon joined the executive team of JPMorgan Chase in 2005. In that year, JPMorgan earned $8.5 billion. In 2012, the company earned $21.7 billion. The pretax, pre-provision results per share went from $4.41 to $8.62 or a gain of 95.5%." The analyst added that "from the end of 2005 to last Friday, the stock price has risen by 19.9%. In this same period the Keefe Bruyette banking Index has fallen by 39.5%. JPMorgan has outperformed its peers by approximately 60% over this timeframe."

Regulators are justified in applying extra scrutiny to JPMorgan Chase's risk management practices, however, when deciding whether or not to "punish" Dimon by taking away one of his titles, investors should keep their ultimate goal at heart, which is to make money.

There's more on JPMorgan Chase below, as the company made the list of 10 cheapest bank stocks to forward earnings estimates.

Honorable Mentions

Our selection approach brings several smaller banks to the list, while excluding the following large banks:

  • Bank of America (BAC). The company's shares closed at $12.24 Friday, returning 6% this year, after more than doubling during 2012. Despite the run-up, the shares trade just below tangible book value, according to Thomson Reuters Bank Insight, and for 9.3 times the consensus 2014 earnings estimate of $1.31, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is 99 cents. Bank of America continues to work through its legacy mortgage repurchase claims. The latest piece of good news for the company is that various institutional investors, including the Federal Home Loan Bank of San Francisco, the attorneys general of New York and Delaware and the Federal Housing Finance Agency, have dropped their objections to the bank's $8.5 billion proposed settlement in June 2011 of mortgage putback claims related to loans originally securitized by Countrywide Financial. Bank of America acquired Countrywide in 2008, and set aside reserves to cover the settlement in the second quarter of 2011. JPMorgan analyst Vivek Juneja said in a note to clients late on Friday that "this removes several objectors to the settlement - few others remain, most notably [American International Group (AIG)]. Juneja pointed out that "the hedge fund that started the objection process, Walnut Creek (Baupost), already withdrew its objection to the deal." He added that "there has been significant overhang on Bank of America's stock because of fears about this settlement being overturned and this should reduce some of those concerns." More of Bank of America's mortgage overhang was removed on Monday, and in a very big way, as the company and MBIA (MBI) announced a "comprehensive settlement" of claims against the bank by the bond insurer. As part of the settlement, Bank of America will extend a $500 million credit line to MBIA. In turn, Bank of America will receive warrants allowing the bank to purchase 9.94 million MBIA shares for $9.59 a share, which can be exercised at any time through May 2018. MBIA's shares rose 45% to close at $14.29, putting Bank of America "in the money" on the warrants, by $4.70 per MBIA share, or approximately $46.7 million. Bank of America's shares were up over 5% to close at $12.88.
  • Discover Financial Services (DFS). The shares closed at $45.93 Friday, trading for 9.6 times the consensus 2014 EPS estimate of $4.80. The consensus 2013 EPS estimate is $4.56. Discover achieved a very strong first-quarter return on equity of 27%, and with its consistent earnings performance and continued growth, seems like a steal right here. Please see TheStreet's earnings coverage for details on the company's financial performance.
  • Wells Fargo (WFC). The shares closed at $37.74 Friday, returning 11% this year, following a 27% return during 2012. The shares trade for 9.7 times the consensus 2014 EPS estimate of $3.90. The consensus 2013 EPS estimate is $3.68. Wells Fargo has been one of the strongest and consistent earnings performers among large banks through the credit crisis and recovery. The company's first-quarter return on tangible common equity was 16.75%, according to Thomson Reuters Bank Insight. Based on a quarterly payout of 30 cents, the shares have a dividend yield of 3.18%. The company in March said it had received Federal Reserve approval for "a proposed increase in common stock repurchase activity for 2013 compared with 2012." Wells Fargo's common share buybacks during 2012 totaled $3.9 billion.

Here are the 10 actively traded bank stocks trading at the lowest multiples to 2014 consensus earnings estimates:

1 of 11

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