Bank of America Spinoff's a Winner: Morgan Stanley

NEW YORK ( TheStreet) -- Once again, analyst ratings changes reflect the unfolding theme that bank stock investors need to move beyond distressed-market bargain shopping and focus on names with strong earnings growth potential.

As discussed in our recent look at cheaply priced to 2013 earnings estimates and Guggenheim's bank picks, the "bargain shopping" approach of looking for names trading for low multiples to tangible book values isn't going to cut it for long-term investors, especially when you consider how significant this year's bank stock rally has been.

The KBW Bank Index ( I:BKX) was up 27% year-to-date through Wednesday's close at 49.90, with many of the most familiar names seeing a significant pop following the completion of the Federal Reserve's annual bank stress tests last Tuesday.

Morgan Stanley analyst Ken Zerbe said on Thursday that "it is too early to aggressively build positions in the banks," despite the implied boost to net interest margins from the recent rise in the yield on 10-year U.S Treasury securities, and that the "stress test results provide little direct benefit to the mid-cap banks given most were more than sufficiently capitalized already, with a median Tier 1 common ratio of 12.1%."

As we have emerged from the credit crisis, one ways for investors to make comparisons among bank and thrift holding companies facing lingering, but declining, credit costs that skew earnings, has been to focus on price multiples to tangible book value. With the sector now having moved so far ahead in such a short time, this broad approach will no longer work for long-term investors.

Two of the best-known U.S banking names still trade at discounts to tangible book value, but for long-term investors who can look beyond a one-year time-frame, the forward price-to-earnings multiples are very attractive, especially for investors who believe in this economic recovery:
  • Shares of Bank of America (BAC) closed at $9.82 Wednesday, returning 77% year-to-date, following a 58% drop during 2012. To put those return numbers in perspective, the shares have had a negative return of 28% for the past 52 weeks. Investors have taken comfort that the company's passing stress test grade from the Federal Reserve takes a common equity raise off the table. The shares trade for 0.8 times tangible book value, according to HighlineFI, and while they may appear expensive, at 14 times the consensus 2012 earnings estimate of 69 cents a share, among analysts polled by Thomson Reuters, they look positively cheap, at eight times the consensus 2013 EPS estimate of $1.19.
  • Citigroup (C) closed at $37.80 Wednesday, returning 44% year-to-date, following last year's 44% drop. The 52-week return is a negative 14%. Like Bank of America, the shares trade for 0.8 times tangible book value. Citi trades for 9.5 times the consensus 2012 EPS estimate of $3.97, and for just under eight times the consensus 2013 EPS estimate of $4.78.

Earnings growth is the new theme, as we see from Morgan Stanley's ratings actions:

First Republic Bank
Shares of First Republic Bank ( FRC) of San Francisco closed at $31.67 Wednesday, returning 3% year-to-date, following a 5% return during 2011.

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First Republic was acquired by Bank of America as part of the purchase of Merrill Lynch in January 2009, and then sold in July 2010 to an investor group that included Colony Financial ( CLNY) and General Atlantic LLC and was led by First Republic's original management team. First Republic completed a public offering in December of 2010.

Morgan Stanley analyst Ken Zerbe on Thursday upgraded his rating for First Republic to "Overweight" from "Equal Weight," while raising his price target for the shares to $36 from $34, calling the institution "one of the few banks that can post double-digit organic earnings growth in this environment," as well as "one of the rare high-quality growth bank stocks that has underperformed given the risk rally, providing downside protection if bank valuations were to correct.

First Republic trades for 1.7 times tangible book value and 12 times the consensus 2013 EPS estimate of $2.72.

Zerbe feels that First Republic's relatively high multiple to forward earnings is justified, when compared to "several high-quality peers with strong growth potential and a focus on a high net worth and/or an entrepreneurial client base, including City National ( CYN), SVB Financial ( SIVB), and Signature Bank ( SBNY), trade at an average of 16.4x 2013e EPS"

The analyst expects First Republic to increase its average loan balances by 20% this year, followed by loan growth of 13% during 2013, saying that "a big part of its strategy is expansion in NYC and Boston, where it is growing by hiring lenders and opening new branches, but it is also putting a lot of resources into Silicon Valley given the wealth being created by the tech industry.

Zerbe estimates that First Republic will earn $2.63 a share during 2012, followed by 2013 EPS of $2.62. The analyst warned that "the potential for another secondary offering is also a material risk, given the stock fell 4.5% when the most recent offering was announced. The original private equity investors still own 39% of the company, but down from roughly 65% in December 2010 when shares began trading."

Interested in more on Capital One Financial? See TheStreet Ratings' report card for this stock.

Associated Banc-Corp
Shares of Associated Banc-Corp ( ASBC) of Green Bay, Wis., closed at $14.52 Wednesday, returning 30% year-to-date, following a 26% decline last year.

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On February 15, the company raised its quarterly dividend to five cents, from a penny. Based on the new quarterly payout, the shares have a dividend yield of $1.39.

The shares trade for 14 times the consensus 2012 EPS estimate of $1.03.

Zerbe on Thursday downgraded Associated to "Underweight" from "Equal Weight," while leaving his $13 price target unchanged, "as the positive story (which we believe is still intact) is now priced into the shares."

The analyst added that "ASBC's turnaround story remains intact, but its valuation, at 16.5x 2013e EPS versus the group at 13.1x, looks stretched given slowing loan growth, modest net interest margin compression, and a return on equity that is 300-400 bps below peers through 2015."

Zerbe thinks investors should look elsewhere in the mid-cap banking space for solid picks, but on the bright side, said that Associated's "New CEO Philip Flynn has done a good job aggressively addressing credit problems," since net loan charge-offs have steadily declined since their peak during the fourth quarter of 2009, and problem asset have declined for seven straight quarters.

The analyst added that Associated was taking commercial and industrial loan market share " by hiring established lenders and expanding its specialized lending capabilities," growing period-end loans 11% Y/Y in 2011."

Zerbe estimates Associated Banc-Corp will earn 89 cents a share this year, followed by 2013 EPS of 88 cents.

Interested in more on Associated Banc-Corp? See TheStreet Ratings' report card for this stock.

First Horizon National
Shares of First Horizon National ( FHN) of Memphis, Tenn., closed at $10.89 Wednesday, returning 36% year-to-date, following last year's 32% decline.

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Way back on Dec. 22, JPMorgan analyst Steven Alexopoulos called First Horizon his " top pick" for 2012, but the shares have risen 39% since closing at $7.82 on Dec. 21.

The shares trade for 12 times the consensus 2013 EPS estimate of 93 cents.

Ken Zerbe on Thursday downgraded First Horizon to "Equal Weight" from "Overweight," since the shares had reached his $11 price target "and the risk/reward is now balanced, with earnings growth from expense saves offset by the possibility of ongoing elevated GSE putback expense."

Zerbe said that First Horizon's "positive story (which we believe is still intact) is now priced into the shares, in our view, and we see more upside elsewhere in the group. The analyst thinks the stock is fairly valued, "given the company's strong earnings growth prospects, driven by expense declines, are balanced by the risks of mortgage putback expense remaining elevated and higher credit losses."

The analyst estimates that First Horizon will earn 62 cents a share this year, followed by 2013 EPS of 84 cents.

Interested in more on First Horizon National? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.