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Two 'Top Picks' Among Mid-cap Bank Stocks

NEW YORK (TheStreet) -- A decline in analysts' earnings estimates over the near term could cause further harm to regional bank stock prices, according to Credit Suisse analyst Craig Siegenthaler, who on Tuesday highlighted his two favorite regional names.

"We remain Overweight the Mid Cap Bank sector with a 12 month plus outlook, but believe that weaker near-term fundamental trends may not be fully embedded in Consensus estimates," Siegenthaler wrote in a note to clients. Many banks beat fourth-quarter earnings estimates because of "lower quality drivers," including lower amortization of premiums paid for assets, and the release of loan loss reserves.

It is typical for banks during an economic recovery to lower their quarterly provisions for loan loss reserves to levels that are below their loan charge-offs, just as banks tend to over-reserve during recessions. One reason for this is that regulators from on over-reserving during "good times," because banks can then alter their quarterly provisions to "smooth out" earnings growth.

"[W]e we do not view these as sustainable drivers of earnings growth and are now 3% / 4% below consensus on 2014 / 2015 EPS," Siegenthaler wrote. Oppenheimer still has an "overweight" outlook for regional banks as a sector, however, based on "capital deployment opportunities," including increased loan growth, higher dividends and increased stock repurchases, as well as the potential for expanding net interest margins when the Federal Reserve finally begins to raise its target for the federal funds rate.

Must Read: FirstMerit Stock Has 32% Upside, Says Oppenheimer

Most coverage of Federal Reserve policy over the past year has focused on the central bank's "QE3" purchases of long-term bonds, which have now been curtailed to a net $65 billion a month. The Federal Open Market Committee in December made a long-anticipated decision to "taper" the bond purchases to $75 billion a month from the $85 billion a month they were running at since September 2012. The FOMC last week made its second $10 billion cut in the monthly purchases.

The end of the Federal Reserve's massive balance sheet expansion is expected to push long-term interest rates higher, as the central bank tries to get back to focusing on its main policy tool -- the short-term federal funds rate, which has been held to a target range of zero to 0.25% since late 2008.

Since many classes of assets, including shorter-term securities, home equity loans and some commercial loans are indexed to the federal funds rate, banks are continuing to face pressure on their net interest margins as assets reprice lower. Siegenthaler expects a positive effect on banks' margins and stock prices when the FOMC begins raising the federal funds rate during the second half of 2015, rather than in the first half of 2016, as is currently baked into consensus EPS estimates.

Expense cuts have been another major theme for banks over the past several years, but spending on improved regulatory compliance systems and "mobile/remote banking technology" could cause EPS estimate declines over the short term, according to Siegenthaler.

On a brighter note, he added that "commercial growth can drive an acceleration in total loan growth to ~4.5% y/y in 2014 from ~2% in 2013 first half of 2016."

The KBW Bank Index (I:BKX) has pulled back 5% this year through Tuesday's close at $66.18, following gains of 35% during 2013 and 30% during 2012. Oppenheimer projects regional bank stocks to show gains 10% for 2014, or 15% from Tuesday's levels through the end of the year.

Favorite Regional Bank Stocks

Siegenthaler's "top picks" among "outperform" rated regional bank stocks are KeyCorp (KEY - Get Report) of Cleveland and First Horizon National (FHN - Get Report) of Memphis, Tenn.

Shares of KeyCorp closed at $12.48 Tuesday, down 8% this year, following a 62% return during 2013, which was the best performance last year among the 24 component stocks of the KBW Bank Index. KeyCorp's shares trade for 1.2 times tangible book value and for 11.0 times the consensus 2015 earnings estimate of $1.13 a share, according to Thomson Reuters Bank Insight. The consensus 2014 EPS estimate is $1.02.

Siegenthaler's price target for KeyCorp is $15, based on expected year-end 2014 multiples of 13.3 times his 2015 EPS estimate, which matches the consensus, and 1.5 times year-end tangible book value.

With an estimated Basel III Tier 1 common equity ratio of 10.6% and expected EPS growth in the "mid single digits," KeyCorp has "further room to increase share repurchases / dividends," as well has having further room to cut expenses, according to the analyst.

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