'Storm Is Brewing' for Banks

NEW YORK ( TheStreet) -- A net interest margin storm is brewing for regional banks, according to JPMorgan Chase analyst Steven Alexopoulos.

JPMorgan on Tuesday established 2013 price targets for most of the 27 mid-cap banks covered by the firm, and while Alexopoulos said "we see sector upside from current levels in the 13% range through YE 2013," which he termed "a decent level of return," the analyst also said that "given the risks of QE3, and the likely further flattening of the yield curve tied to such an action, we would be locking in profits at current valuation levels."

"QE3" refers to another possible round quantitative easing through long-term Treasury securities purchases by the Federal Reserve, in an effort to bring long-term rates down further, in order to spur economic growth.

With the benchmark federal funds rate in a range of zero to 0.24% for a prolonged period, there's a limit to how much further banks can expect their funding costs to decline. Meanwhile, with strong deposit growth, banks are continually investing in securities and new loans with ever-declining rates, pressuring net interest margins (NIM) and reducing profitability.

Alexopoulos said that since the first quarter of 2007, "the cost of interest bearing deposits for the group has declined 306 bps to only 0.55% in 1Q12," and that since "loan growth is currently positively impacting the industry's earning asset mix (from cash to loans), there appears to be enough gas in the tank to withstand meaningful NIM pressure perhaps through 2014."

JPMorgan Chase projects the median cost of deposits for mid-cap regional banks to decline to just 27 basis points in the fourth quarter of 2014, but Alexopoulos added that "a looming disconnect between falling asset yields and the industry's ability to further lower deposit costs is a recipe for a NIM storm."

Following the recent string of sluggish economic data, the analyst said "we now think it's too optimistic to assume that the Fed starts a tightening campaign in the beginning of 2014," and "assuming that the current very low level of interest rates will be here over the intermediate term and that the first rate hike is pushed out to 2015, our 2014 and 2015 EPS estimates are coming down by around 13% in each year."

According to Alexopoulos, "if the Fed were indeed to wait until 2015 to begin raising short-term rates, and then raises rates by a quarter point at each meeting of the Open Market Committee, "this would imply a more normal Fed Funds rate (of 4.25%) by YE2016," also implying that "the first year bank investors could reasonably expect a more normal level of earnings from the industry is in 2016!"

Despite that gloomy outlook, JPMorgan has "Overweight" ratings on nine of the 27 mid-cap regional banks covered by the firm. Here are Alexopoulos's two "top longs," along with two more favored "growth plays," and the analysts' two "top shorts" in the space:

First Horizon National Corp.
Shares of First Horizon National Corp. ( FHN) of Memphis, Tenn., closed at $8.33 Monday, returning 4% year-to-date, following 32% decline during 2011. FHN Chart FHN data by YCharts

The shares trade just below their reported March 31 tangible book value of $8.78, and for nine times the consensus 2013 earnings estimate of 89 cents, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is six cents, including an expected net loss of 50 cents a share when the company announces its second-quarter results on July 20, in the wake of a $272 million charge for mortgage putback reserves and related litigation.

Steven Alexopoulos rates First Horizon "Overweight," with an $11.50 price target, saying on Tuesday that "the biggest cat is already out of the bag," as "the company's preannouncement that it is taking a $272 million pre-tax charge related to mortgage putbacks and litigation expense in 2Q drove a rally in the shares as this was seen as a pull forward of expected provision needed for losses through 2013."

With JPMorgan expecting First Horizon's average loans to decline at an annualized pace of 8%, while securities grow 15% quarter-over-quarter, Alexopoulos expects to see some support to the company's net interest margin, contracting by two basis points to 3.10%.

The analyst also anticipates the company will announced that it repurchased 5.4 million shares during the second quarter, which is the same pace as in the first quarter.

JPMorgan estimates First Horizon to report core earnings of 28 cents a share this year, followed by core EPS of $1.09 in 2013.

Alexopoulos calls First Horizon "a turnaround story" and said on Tuesday that "while we could still see unexpected surprises, with each passing quarter not only is the company boosting earnings power via buybacks, but we also believe we get one step closer to the company evolving into one of the highest return on tangible equity banks in the industry."

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

First Republic Bank
Shares of First Republic Bank ( FRC) of San Francisco closed at $32.99 Monday, returning 8% year-to-date, following a 5% return during 2011. FRC Chart FRC data by YCharts

The shares trade for 1.7 times their reported March 31 tangible book value of $18.91, and for 11 times the consensus 2013 EPS estimate of $2.89. The consensus 2012 EPS estimate is $2.72.

The bank is expected to report its second-quarter results on July 18, with analysts estimating a 65-cent profit, declining from 67 cents in the first quarter, but increasing from 64 cents during the second quarter of 2011.

First Republic was acquired by Bank of America ( BAC) 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.

The bank then completed a public offering in December of 2010.

Alexopoulos rates First Republic "Overweight," with a $41 price target, and said on Tuesday that "with management still calling the pipeline its best ever amid good activity levels within the geographic footprint, we look for loan growth to remain strong at 18% annualized, moderating from a very strong 25% pace of growth in 1Q." The analyst expects First Republic's net interest margin to narrow by six basis points from a relatively strong 4.39% in the first quarter.

First Republic's first quarter net interest margin declined from 4.53% in the fourth quarter and 4.76% in the first quarter of 2011.

With the bank expanding its wealth management business through new office openings in Boston and now in Delaware, JPMorgan looks "for fee income to increase 4% linked-quarter on the back of wealth management fees."

The company plans to begin paying a quarterly dividend of 10 cents, beginning in the third quarter.

Alexopoulos estimates First Republic will earn $2.06 a share for all of 2012, followed by 203 EPS of $2.26.

The analyst said that First Republic "could be the strongest generator of intrinsic value in our group" of covered mid-cap regional banks, and that the bank differentiates itself from most of the competition by targeting "exclusively either high net worth or those on the path to becoming high net worth," while delivering "service levels that are among the highest in the industry today."

Alexopoulos illustrated his point on customer service by saying that "while many banks struggle to get to 2-3 products sold per retail customer, FRC is currently averaging 9 products per customer."

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

SVB Financial Group
Shares of SVB Financial Group ( SIVB) of Santa Clara, Calif., closed at $56.80 Monday, returning 19% year-to-date, following a 10% decline during 2011. SIVB Chart SIVB data by YCharts

The shares trade for 1.7 times tangible book value, according to Worldscope data provided by Thomson Reuters, and for 15 times the consensus 2013 EPS estimate of $3.74. The consensus 2012 EPS estimate is $3.47.

Analysts expect the company to report second-quarter earnings of 85 cents a share, increasing from 78 cents the previous quarter, but declining from 95 cents a year earlier.

Alexopoulos rates SVB Financial Group "Overweight," with a price target of $71, saying his firm expected a "13% annualized increase in net interest income , up on continued growth in average earning assets and 3 bps of expected NIM expansion." The analyst also expects "period-end loan growth of $340 million, or a near-20% annualized pace, while deposit growth should rebound from flattish levels last quarter, up 10% annualized."

When SVB announces its second-quarter results, Alexopoulos is also looking "for additional color on the launch of a full-service UK branch during 2Q, as well as the pending launch of its joint venture in China."

JPMorgan estimates that SVB will earn $3.32 a share this year, followed by EPS of $3.56 in 2013.

Alexopoulos said that "of our entire coverage universe, management at SIVB has been the most active in working to take its business overseas," with the new London office, "a small presence in Israel and an announced joint venture with a bank in China, which it has indicated is expected to get off the ground in 2012." The analyst added that "at a time when European banks are struggling with the current market turmoil, which has shown no signs of abating, the company's UK branch rollout could not be timelier," as "SIVB has already been lending for some time in the UK, with management recently citing a strong loan pipeline and expecting strong global growth."

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

Signature Bank
Shares of Signature Bank ( SBNY) of New York closed at $60.71 Monday, returning 1% year-to-date, following a 20% return during 2011. SBNY Chart SBNY data by YCharts

The shares trade for twice their tangible book value, according to Worldscope data provided by Thomson Reuters, and for 14.5 times the consensus 2013 EPS estimate of $4.18. The consensus 2012 EPS estimate is $3.65.

Analysts expect the bank to report second-quarter EPS of 89 cents, compared to 90 cents the previous quarter and 87 cents a year earlier.

Alexopoulos rates Signature Bank "Overweight," with a $75 price target, and said Tuesday that he expects the bank's "strong loan growth to continue," and for its second-quarter net interest margin to decline by two basis points to 3.48%. JPMorgan expects Signature Bank "to continue to be a standout on the loan growth front, with ~$550 million of period-end loan growth expected, or nearly 30% annualized growth."

Alexopoulos estimates that Signature Bank will earn $3.51 a share for all of 2012, followed by 2013 EPS of $3.81.

Signature Bank during the first quarter launched a special finance subsidiary called Signature Financial, hiring "of one of Long Island's most respected C&I-focused, middle market teams," according to CEO Joseph DePaolo.

Alexopoulos said on Tuesday that "although growth metrics from Signature are at best-in-class levels, over the past several quarters the market seems to have now grown accustomed to very strong balance sheet growth out of the company with SBNY shares lagging peers on the day of earnings being reported." The analyst went on to say that the bank's expansion of its lending team "couldn't have come at a better time," and that the new unit "seems to be positioned to add a cylinder or two to the company's loan growth engine."

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

BancorpSouth
Shares of BancorpSouth ( BXS) of Tupelo, Miss., closed at $14.64 Monday, returning 33% year-to-date, following a 30% decline during 2011. BXS Chart BXS data by YCharts

The shares trade for 1.1 times tangible book value, according to Worldscope data provided by Thomson Reuters, and for 15 times the consensus 2013 EPS estimate of 95 cents. The consensus 2012 EPS estimate is 84 cents.

BancorpSouth is expected to report its second-quarter results on July 24, with the consensus estimate among analysts being a 20-cent profit, following EPS of 25 cents the first quarter, and 15 cents a year earlier.

Alexopoulos rates BancorpSouth "Underweight," with a price target of $13, and on Tuesday called the company one of his "top shorts," saying that "while credit challenges remain an overhang, earning the cost of capital is the next challenge" and that "the potential pipeline for problem assets remains sticky," as "special mention loans increased 18% or $22 million" during the first quarter.

The analyst added that "With +$1 billion CDs maturing in the coming quarters, the company has further room to lower its deposit costs, which now stand at 84 bps. However, in the absence of loan growth, net interest income is likely to remain flat."

Alexopoulos estimates that BancorpSouth will earn 81 cents a share this year, followed by 2013 EPS of 92 cents.

Despite the positives he noted, Alexopoulos sees BancorpSouth's shares as "overvalued," trading at "a 20% premium to peers," adding that "we don't see the required level of growth or profitability levels to render BXS a peer performer."

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

Astoria Financial
Shares of Astoria Financial ( AF) of Lake Success, N.Y., closed at $10.01 Monday, returning 20% year-to-date, following a 36% decline during 2011. AF Chart AF data by YCharts

The shares trade for 0.9 times their reported March 31 tangible book value of $11.22, and for 15 times the consensus 2013 EPS estimate of 65 cents. The consensus 2012 EPS estimate is 53 cents.

Astoria during the first quarter cut its quarterly dividend to four cents from 13 cents, as the company suffered year-over-year declines in net interest income and margin. Based on the current payout the shares have a dividend yield of 1.60%.

The company will report its second-quarter results on July 18, with analysts expecting a 13-cent profit, following EPS of 11 cents the previous quarter and 18 cents a year earlier.

The company's first-quarter net interest margin was a relatively narrow 2.20%, unchanged from the fourth quarter, but declining from 2.40% during the first quarter of 2011.

Alexopoulos rates Astoria "Underweight," and on Tuesday called the company one of his "top shorts," and said he expects the second-quarter net interest margin to contract by two basis points to 2.18%, and with the dividend cut, expects the company's tangible common equity ratio "to improve modestly to ~6.5%."

Alexopoulos expects Astoria to earn 46 cents a share this year, followed by 2013 EPS of 52 cents.

The analyst said on Tuesday that "even looking all the way to 2016, there is still no clear path to AF earning above its cost of capital," and with "AF now under the regulatory guidance for capital ratios of one of the toughest regulators, the OCC, in our view, it's very unlikely that the company will return to its previously thin level of tangible common equity."

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

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

>Contact by Email.

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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