NEW YORK (TheStreet) -- The regional banks have surged along with the rest of the financial sector so far in 2010, and now it's time to see if the results can keep up with the stocks.
"We believe investor focus will start to shift from credit quality and capital (which dominated the outcome of '08/'09 results) to long-term earnings drivers," including loan growth, net interest margin, fee income and expenses, writes Credit Suisse analyst Craig Siegenthaler in a research note to clients. "This could start to differentiate the banks that can post stronger loan growth (or lack of deterioration) and
net interest margin improvement." From a bottomline perspective, performance will still be weak across the majority of regional banks, however. According to Thomson Reuters, the 11 regional banks listed in the S&P 500 are expected to post an aggregate loss of $972 million vs. a loss of $7.56 billion in the same period a year earlier, even with expected earnings growth of 205% in the overall financial sector, Thomson Reuters says. "Bottom line results will be poor given expectations for slowing pre-provision profits, including lower earning asset levels, seasonally weak fee income, and high expense levels. We expect about half of our coverage universe to post an operating loss in the quarter, with the remaining banks posting modestly improving profits," according to Todd Hagerman, an analyst at Collins Stewart. Hagerman covers 18 large and mid-size banking companies. Among the larger regional names, Hagerman predicts further upside in SunTrust, Fifth Third and Regions, all rated at buys, but says Zions Bancorp ( ZION), Synovus ( SNV) and KeyCorp are beginning to look expensive and rated at hold. Overall loan demand is also expected to continue be weak combined with declining loan balances as banks work to shed troubled loans and shore up their willingness to lend out again. Still Hagerman believes that a credit inflection point occurred during the first quarter as reserve builds "will likely diminish significantly and charge-offs are likely to decline." Outside of credit, another bright spot could be expansion of net interest margins as banks continue to shift deposits away from higher priced CDs and other interest-bearing accounts and reap benefits from lower borrowing costs. Goldman Sachs upgraded KeyCorp to a buy rating on Wednesday saying the company is most likely to benefit from a net interest margin tailwind. Goldman analysts note that KeyCorp, for example, has the "biggest and most expensive CD book with about two-thirds of it re-pricing this year," followed by Hudson City ( HCBK) and Huntington Bancshares ( HBAN).
Credit Suisse's Siegenthaler believes a pullback in the stocks in the wake of earnings is inevitable given their outperformance. "We believe investors may initially react positively to
first quarter results ... however we expect the excessive positive sentiment to drive a 10-15% pullback in stock prices after earnings," he says. "While we remain long-term bulls on the U.S. Regional Banks, we are more cautious over the near-term due to excessive sentiment and richer valuations." In the end, delivering on or exceeding the ramped-up credit quality expectations will take precedence, or as Bank of America Merrill Lynch analysts put it, banks will need to show an "absolute improvement in credit metrics" for their stocks to build on hefty year-to-date gains. --Written by Laurie Kulikowski in New York.