5 Banks Cutting Their Way to Bigger Profit

NEW YORK ( TheStreet) -- Guggenheim analyst Marty Mosby expects large U.S. banks to show "6% sequential growth in operating earnings" for the second quarter, when the sector's earnings season begins on Friday.

While many analysts have been focused on the " coming storm" from narrowing net interest margins, as short-term rates remain near zero and long-term rates continue to decline, Mosby said on Wednesday that investors should not "get lost on the headwinds for revenue growth," because, "as the Large Cap Banks are still in earnings recovery mode, efficiency improvements are just as important."

A bank's efficiency ratio is the number of pennies of overhead expense for each dollar of a bank's revenue, with adjustments made for certain items. Thomson Reuters Bank Insight defines the efficiency ratio as total noninterest expense plus income from minority interests divided by the sum of tax-adjusted net interest income and noninterest income.

Mosby said that "after improving 1.7 percentage points in 1Q12, we are forecasting a 2.5 percentage point gain in 2Q12's efficiency ratio, which is responsible for more than 100% of this quarter's expected sequential increase in EPS."

The analyst sees a silver lining for investors heading into second-quarter earnings, since "the recent downward pressure on our Large Cap Bank stock prices has pulled the stock prices further below the current recovery in earnings," which "has created pent-up positive momentum for our Large Cap Banks that could potentially provide the eventual catalyst for a traditional bank recovery trade if earnings per share can continue to growth through year-end 2012."

Over the past two years, most large banks have been allowing their loan loss reserves to decline, in line with the decline in loan charge-offs. This has padded earnings results, which is why analysts focus on "pre-provision" earnings. Guggenheim projects "sequential growth in pre-provision earnings per share... following a three year slide from 2008 through 2011," and suggests "this inflection point should result as revenues begin to grow, operating efficiencies begin to improve, and deployment of excess capital through acquisitions and share repurchases creates positive earnings momentum in 2012."

Mosby expects "favorable 2Q12 operating earnings surprises" with "double digit annualized sequential growth" in earnings from four large-cap banks covered by Guggenheim, including U.S. Bancorp ( USB), Wells Fargo ( WFC), M&T Bank ( MTB), and SunTrust ( STI), and said that the four are "are positioned to benefit the most by reporting better than expected earnings this quarter while generating strong earnings momentum."

The analyst added that "most of the banks with unfavorable earnings expectations relative to market expectations are related to unusual items, and include JPMorgan Chase ( JPM), First Horizon National Corp. ( FHN), Regions Financial ( RF), and Zions Bancorporation ( ZION)," and that "the inclusion of these large unusual items is inconsistent across the market estimates, making the consensus less useful for these banks."

Factoring in current stock price valuations, here are the three names Mosby expects to head higher on the strength of operating earnings improvements, followed by two names with "the best return-to-risk ratios and strong operating returns which should justify an eventual revaluation":

First Horizon National Corp.
Shares of First Horizon National Corp. of Memphis, Tenn., closed at $8.24 Monday, returning 3% year-to-date, following 32% decline during 2011. FHN Chart FHN data by YCharts

The shares trade for 0.9 times their 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, which will include a $272 million charge for mortgage putback reserves and related litigation.

Mosby rates First Horizon a "Buy," with a $10 price target, although he expects First Horizon "to fall significantly short of market expectations this quarter but to more than double its operating earnings per share from 1Q12," to 27 cents a share.

The analyst said that "the impact of the $272 million special reserve for expected future mortgage repurchase and litigation losses should cloud this quarter's results; however, the elimination of future expenses related to mortgage repurchase expenses should significantly accelerate the expense savings needed to push FHN's operating earnings higher."

Mosby estimates that First Horizon will report earnings of 24 cents a share for all of 2012, followed by EPS of $1.10 in 2013.

Guggenheim expects First Horizon's efficiency ratio to improve from 84% in 2011 to 67% in 2013.

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

Regions Financial
Shares of Regions Financial of Birmingham, Ala., closed at $6.43 Tuesday, returning 50% year-to-date, following a 38% decline during 2011. RF Chart RF data by YCharts

The shares trade for eight times the consensus 2013 EPS estimate of 77 cents, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is 61 cents.

After selling its Morgan Keegan brokerage subsidiary and completing a $900 million common share offering during the first quarter, Regions in early April repaid $3.5 billion in government bailout funds received during 2008 through the Troubled Assets Relief Program, or TARP.

The company will announce its second-quarter results on July 24, with the analyst consensus being a second-straight quarterly profit of 14 cents a share, compared to earnings of four cents a share during the second quarter of 2011.

Mosby estimates that Regions will report second-quarter earnings of 13 cents a share, missing the consensus estimate by a penny "due to higher unusual expenses tied to the repayment of TARP; however, this represents a 23% sequential improvement in operating earnings from 1Q12. The analyst said that "the noise in the reported results related to the repayment of TARP could mask the real story this quarter; we think RF's operating earnings could actually climb to $0.18," and build "toward $0.20 by year-end 2012, justifying a significant favorable adjustment in expected earnings power."

The analyst estimates that Regions will report EPS of 66 cents for all of 2012, followed by 2013 EPS of 96 cents.

Guggenheim forecasts that Regions Financial's efficiency ratio will improve from 64% in 2011 to 60% in 2013.

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

U.S. Bancorp
Shares of U.S. Bancorp of Minneapolis closed at $31.90 Tuesday, returning 19% year-to-date, following a 2% return during 2011. USB Chart USB data by YCharts

The shares trade for just over three times tangible book value, according to Thomson Reuters Bank Insight, and for 11 times the consensus 2013 EPS estimate of three dollars. The consensus 2012 EPS estimate is $2.77.

Based on a quarterly payout of 19.5 cents, the shares have a dividend yield of 2.45%.

USB will report its second-quarter results on July 18, with the consensus among analysts being a 70-cent profit, increasing from 67 cents the previous quarter and 60 cents a year earlier.

Mosby expects "USB to exceed market expectations by 5% this quarter and experience a 9% sequential increase in operating earnings to 73 cents a share from 1Q12," and that "favorable seasonal trends in processing businesses and increased mortgage refinance activities should push fee income up 6% sequentially from 1Q12 to 2Q12E."

Mosby added that he expected "organic revenue growth to favorably impact USB's earningsper share by 4% in the second quarter, the strongest organic revenue growth among our Large Cap Banks." Another "1.4% in sequential earnings per share growth" is expected from the repurchase of 25 million shares during the second quarter.

The analyst estimates that the company will earn $2.94 a share for all of 2012, followed by EPS of $3.26 in 2013.

Guggenheim estimates that U.S. Bancorp's efficiency ratio will improve from an already strong 52% in 2011 to 49% in 2013.

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

JPMorgan Chase
Shares of JPMorgan Chase closed at $34.25 Tuesday, returning 1% year-to-date, following a 20% decline during 2011. JPM Chart JPM 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.

The shares trade just below their reported March 31 tangible book value of $34.91, and for six times the consensus 2013 earnings estimate of $5.30 a share, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is $4.30.

Based on a 30-cent quarterly payout, the shares have a dividend yield of 3.50%.

JPMorgan Chase's shares have declined 16% since closing at $40.74 on May 10, right before CEO James Dimon disclosed a hedge trading loss by its Chief investment Office (CIO) estimated at "slightly more than $2 billion." Dimon said that as the company wound down the hedge trading positions, the losses might climb higher, and the New York Times reported on June 28 that cumulative losses from the trades could eventually total as much as $9 billion.

The company will kick off earnings season for large banks at 7AM EST on Friday, with the analyst consensus being for JPM to report a 78-cent profit, declining from $1.31 in the first quarter, and $1.27 during the second quarter of 2011.

Mosby said that "what is most important about this quarter's results is whether JPM has gotten the hedge position pulled down to a manageable level," and that "if the potential for future losses is negligible, we would expect JPM's stock price should begin to recapture" the value lost since Dimon's announcement in May. The analyst is so enthusiastic about JPMorgan's shares at their current valuation that "a current hedge loss as high as $10 billion would not deter us from our BUY recommendation if the position has been neutralized. "

Mosby estimates that JPMorgan Chase will report earnings of $4.50 a share for all of 2012, followed by EPS of $5.85 in 2013.

Guggenheim estimates that JPMorgan's efficiency ratio will increase from 60% in 2011 to 62% in 2013.

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

Wells Fargo
Shares of Wells Fargo closed at $32.97 Tuesday, returning 21% year-to-date, following a 10% WFC Chart WFC data by YCharts

The shares trade for twice their tangible book value, according to Thomson Reuters Bank Insight, and for nine times the consensus 2013 EPS estimate of $3.65. The consensus 2012 EPS estimate is $3.28.

Wells Fargo will report its second-quarter results on July 13, with the consensus estimate being an 81-cent profit, increasing from 75 cents the previous quarter and 70 cents a year earlier.

Mosby expects Wells Fargo's second-quarter operating earnings to increase 8% from the first quarter to 82 cents, and said that "strong mortgage banking fee income and balance sheet growth is expected to overcome 5 basis points of net interest margin compression." The analyst added that "the critical development this quarter is the expected decline in expenses" which he expects "to fall over $150 million this quarter, even though revenues are expected to increase $400 million." The combination of increasing revenue and declining expenses "should push WFC's efficiency ratio down almost 2 percentage points sequentially in 2Q12E to 57.7%."

Mosby estimates that Wells Fargo will report earnings of $3.35 a share for all of 2012, followed by EPS of $3.80 in 2013.

Guggenheim estimates that Wells Fargo's efficiency ratio will improve from 58% in 2011 to 56% in 2013.

Interested in more on Wells Fargo? 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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