5 Long-Term Bank Stock Picks From Jefferies (Update 1)

Updated with comments from Credit Suisse about PNC's expected compliance with Basel III capital requirements, in mid-2014.

NEW YORK ( TheStreet) -- Following the banking sector's remarkable first-quarter run, Jefferies analyst Ken Usdin on Monday highlighted his five "top long-term picks."

"At 12x 2013 earnings" estimates, Usdin said that current price "valuation seems pretty fair" for most of the banks covered by Jefferies, and said "the group will likely need even-better loan growth" than analysts expect, "to power through from here."

Of course, some of the best-known banking names outside of Usdin's coverage universe are trading at much lower multiples to forward earnings:
  • Shares of Bank of America (BAC) closed at $9.57 Friday, returning 72% year-to-date, following a 58% plunge during 2011. The shares trade for just eight times the consensus 2013 EPS estimate of $1.20, among analysts polled by Thomson Reuters. Bank of America is also trading at a heavily discounted 0.8 times tangible book value, according to HighlineFI.
  • Citigroup (C) closed at $36.55 Friday, returning 39% year-to-date, following last year's 44% drop. Citi trades trades for eight times the consensus 2013 EPS estimate of $4.78. The shares are also discounted to 0.7 times tangible book value.
  • JPMorgan Chase closed at $45.98 Friday, returning 39% year-to-date, following a 20% decline during 2011. While JPMorgan is generally considered a safer play than BAC or Citi, with the shares trading for 1.5 times tangible book value, the shares still appear cheap to forward earnings, trading for eight times the consensus 2013 EPS estimate of $5.52.

Usdin favors his top picks for various reasons, including tailwinds from strong loan growth, credit improvement, an expanding net interest margin -- the difference between a bank's average yield on loans and investments and its average cost for deposits and wholesale borrowings -- for one name, while most of the industry continues to face narrowing margins as deposits continue to pour in, while interest rates remain low.

Despite a recent spike in long-term interest rates, Jefferies expects net interest margins to "continue to grind lower given lower reinvestment yields and tight spreads on new loan production," with 75% of the firm's covered banks expected to see sequential margin declines.

Usdin expects stable first-quarter fee revenue for lenders, "as seasonal weakness in payments should be mitigated by better mortgage banking and markets-related revenue," adding that "Mortgage banking could be particularly strong given strong yearend pipelines and commentary that gain-on-sale trends are still pretty healthy."

Declining expenses is also expected to be a theme this quarter, as banks finally see material reductions in their outlay to maintain and market repossessed real estate. "Those most levered to improving environmental costs" according to Usdin include BB&T ( BBT), First Horizon National ( FHN), Regions Financial ( RF), Synovus Financial ( SNV), and SunTrust ( STI).

In regard to bank investors' thirst for higher interest rates and wider net interest margins, Usdin said that during the first quarter, "the market appeared to pull forward the potential for the Fed to raise rates sooner than anticipated," in "a marked contrast to fall 2011, when most investors assumed that a near-zero Fed funds rate and a 2.0% 10-year Treasury bond yield would linger for years."

Late in the third quarter, the big theme was the expanded return of capital through dividend increases and share buybacks, approved by the Federal Reserve as part of the regulators annual bank holding company stress tests. Usdin said the capital returns approved by the Fed "were generally larger-than-expected, both in terms of dividend increases and share buyback authorizations," and that for some bank holding companies, "total payout ratios could approach 100% of earnings over the next twelve months."

Jefferies estimates that "usage of excess capital available at year-end '13 could provide an 8% average lift to EPS and add an additional percentage point to return on tangible equity for the large/mid-caps over time," while "for the small to mid-caps , deployment in outer years could drive EPS and ROTE higher by 13% and two percentage points, respectively."

Factoring in net interest margin prospects, loan growth estimates, return off capital, expense management, credit quality improvement and market action, here are Jefferies' top five bank stock picks heading into earnings season. The group is in ascending order, by the upside potential implied by the firm's revised 12-month price targets:

5. PNC Financial Services Group
Shares of PNC Financial Services Group ( PNC) of Pittsburgh closed at $64.49 Friday, returning 12% during the first quarter, following a 3% decline during 2011.

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The shares trade for 9.5 times the consensus 2013 earnings estimate of $6.81 a share, among analysts polled by Thomson Reuters.

PNC on March 13 announced that the Federal Reserve had "accepted its capital plan and did not object to the capital actions, which included recommendations to increase the quarterly common stock dividend in the second quarter of 2012 and a modest share repurchase program under PNC's existing common stock repurchase authorization."

Credit Suisse analyst Moshe Orenbuch said on Monday that PNC plans to repurchase 25 million shares, and that he expects "the company to carefully manage capital ahead of Basel III implementation given the recent deal, potential risk-weighted assets inflation associated with its sub-investment grade securities portfolio ($6bn) and potential capital deductions associated with its BlackRock ( BLK) stake."

Among the largest U.S. banks, Orenbuch expects PNC to achieve full Basel III compliance --- with a Tier one common equity ratio of 7.75%, including a 0.75% buffer as a "systemically important financial institution" -- rather late, in mid-2014. The analyst added that "that the company has options with respect to getting to the minimums faster (selling securities) if it chose to do so."

Orenbuch estimates that PNC's Basel III Tier 1 common equity ratio would be 6.5% at the end of this year, rising to 7.4% at the end of 2013.

PNC is currently paying a quarterly dividend of 35 cents a share, for a dividend yield of 2.17%.

Jefferies analyst Ken Usdin on Monday raised his price target for the shares to $70 from $66, while lowering his 2012 EPS estimate to $5.85 from $6.05, and raising his 2013 estimate to $6.45 from $6.35.

PNC will report its first-quarter results on April 18, and is expected by analysts to post earnings of $1.41 a share, increasing from 85 cents the previous quarter, but declining from $1.57 a share during the first quarter of 2011.

Last quarter, PNC's earnings of $493 million reflected "$240 million of residential mortgage foreclosure-related expenses primarily as a result of ongoing governmental matters, a noncash charge of $198 million related to redemption of trust preferred securities, and an increase in personnel expense of $103 million primarily driven by higher stock market prices and higher business production."

Usdin expects the company to post first-quarter EPS of $1.30, and said on Monday that he likes "PNC into the quarter given underperformance year-to-date, a likely dividend hike/buyback announcement following the early-April Board meeting, and achievable fullyear guidance" with the company estimating 2012 revenue growth ranging between 5% and 8%.

The analyst expects that the company's recent acquisition of RBC Bank (USA) will "likely cause some accounting confusion," but also believes "underlying trends should be strong enough to push the stock higher." Usdin includes 23 cents of merger-related expenses in his first-quarter EPS estimate of $1.30.

Interested in more on PNC Financial Services Group? See TheStreet Ratings' report card for this stock.

4. SunTrust
Shares of SunTrust of Atlanta closed at $24.17 Friday, returning 37% year-to-date, following last year's 40% decline.

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The shares trade for nine times the consensus 2013 EPS estimate of $2.66.

After the Federal Reserve rejected the company's capital plan, SunTrust said in a statement on March 13 that it would "not be increasing its return of capital to shareholders at this time," and that it would maintain its current quarterly dividend of five cents a share, and "redeem certain trust preferred securities at such time as their governing documents permit, including when these securities are no longer expected to qualify as Tier 1 capital."

Ken Usdin on Monday raised his price target for SunTrust by two dollars to $27, while raising his 2012 EPS estimate to $1.60 from $1.05, and lowering his 2013 estimate to $2.60 from $2.70, saying that with SunTrust preannouncing first quarter earnings of more than 29 cents a share, first-quarter expectations are already reflected in the stock price.

The analyst added that "while details about specific line items are scarce, we believe strong mortgage production, progress on expense initiatives, and lower-than-expected environmental expenses are the primary drivers of better-than-expected 1Q results."

SunTrust is scheduled to announce its first-quarter results on April 23. The consensus first-quarter EPS estimate is 31 cents, following earnings of 28 cents a share the previous quarter and eight cents a share during the first quarter of 2011, when the company repaid bailout funds owed to the government for assistance received through the Troubled Assets Relief Program, or TARP. Operating earnings during the first quarter of 2011 were 22 cents a share.

During the fourth quarter, SunTrust saw a 30% sequential decline in noninterest income to $723 million, with mortgage production related losses of $62 million, compared to mortgage production income of $41 million in the third quarter. Mortgage servicing income also declined, to $22 million in the fourth quarter, from $68 million the previous quarter. These items reflected an increased "mortgage repurchase provision, as well as a mortgage servicing rights valuation adjustment arising from anticipated refinance activity from the HARP 2.0 program."

The company's fourth-quarter earnings to common shareholders of $152 million reflected a $143 million reserve release.

Usdin also expects SunTrust to post first-quarter earnings of 31 cents a share.

Interested in more on SunTrust? See TheStreet Ratings' report card for this stock.

3. First Midwest Bancorp
Shares of First Midwest Bancorp ( FMBI) of Itasca, Ill., closed at $11.98 Friday, returning 18% year-to-date, following a 12% decline during 2011.

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The shares trade for 12 times the consensus 2013 EPS estimate of $1.02.

Jefferies analyst Emlen Harmon on Monday raised his price target for First Midwest to $14 from $13, while lowering his 2012 EPS estimate to 70 cents from 75 cents, and lowering his 2013 estimate to $$1.10 to $1.15.

Jefferies said that "progress on credit should be the focal point of the quarter, as the company shifts into growth mode," and that although "it could take a quarter or two for growth to show meaningfully," the firm expects "total loan growth to turn positive this quarter."

The consensus among analysts polled by Thomson Reuters is for First Midwest to report first-quarter earnings of 13 cents a share, compared to five cents a share during the fourth quarter and 10 cents a share, during the first quarter of 2011.

Harmon is slightly ahead of the consensus, estimating first-quarter EPS of 14 cents.

Interested in more on first Midwest Bancorp? See TheStreet Ratings' report card for this stock.

2. First Niagara Financial Group
Shares of First Niagara Financial Group ( FNFG) of Buffalo, N.Y., closed at $9.84, returning 15% year-to-date, following a 35% decline during 2011.

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The shares trade for nine times the consensus 2013 EPS estimate of $1.09.

Based on an 8-cent quarterly payout, the shares have a dividend yield of 3.25%.

First Niagara expects to complete its HSBC ( HBC) branch acquisition on May 18, after which the company will double in size, with roughly 200 branches and 1,200 employees.

Jefferies analyst Casey Haire on Monday raised his price target for the shares by a dollar to $12, leaving his 2012 EPS estimate of 95 cents and his 2013 estimate of $1.10 unchanged.

The consensus first-quarter EPS estimate for First Niagara is 19 cents, following fourth-quarter earnings of 24 cents during the fourth quarter and also during the first quarter of 2011.

Haire matches the consensus, saying he expects "EPS to drop a nickel Q-Q to $0.19, as a pre-announced premium amortization hit and a full-quarter drag from the HSBC deal financing (completed in Dec. '11) weigh on earnings." The analyst also expects the company's earnings "to snap back in 2Q when the HSBC deal closes."

Haire also expects "loan growth to remain positive," especially for commercial and industrial lending, "although a tough pricing environment will keep core net interest margin under pressure."

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

1. Western Alliance BanCorp
Shares of Western Alliance Bancorp ( WAL) of Phoenix closed at $8.47 Friday, returning 36% year-to-date, following a 15% decline during 2011.

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The shares trade for 11 times the consensus 2013 EPS estimate of 77 cents.

Jefferies analyst Casey Haire on Monday raised his price target for the shares to $10.50 from $9.50, while leaving his 2012 EPS estimate of 60 cents and his 2013 estimate of 90 cents unchanged.

Western alliance will report its first-quarter results on April 19, with a consensus EPS estimate of 12 cents, compared to fourth-quarter earnings of seven cents a share, and EPS of three cents, during the first quarter of 2011.

Haire said that estimates the company will post first-quarter EPS of 13 cents and said on Monday that the "biggest wildcard" will be the write-down the company's repossessed real estate, "which should be meaningfully lower Q-Q (our model has $2.5mm vs. $8mm in 4Q) given that only 33% (vs. 66% in 4Q) of the repossessed real estate is up for reappraisal."

The analyst added that "WAL's nine quarter winning streak of revenue growth should continue despite a slower pace of loan growth (vs. 4Q) and net interest margin contraction, as the bank continues to take share against a weak competitive landscape."

Interested in more on Western Alliance Bancorp? See TheStreet Ratings' report card for this stock.

>>To see these stocks in action, visit the 5 Long-Term Bank Stock Picks From Jefferies portfolio on Stockpickr.

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

To contact the writer, click here: Philip van Doorn.

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.

To submit a news tip, send an email to: tips@thestreet.com.
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 TheStreet.com 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.

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