5 'Best' Bank Stock Ideas from Sterne Agee

NEW YORK ( TheStreet) -- Even in the face of regulatory headwinds, a sputtering economic recovery and narrow rate spreads, there are a variety of winning approaches for banks to grow their earnings.

"Bank stocks have climbed a wall of worry this year," according to Sterne Agee analyst Peyton Green, and there's no question that the troubled sector has been a winner, with the KBW Bank Index ( I:BKX) returning 24% through Monday's close at 48.89.

So where do investors turn now? One approach is to keep focusing on some of the best-known industry names, which continue to trade at huge discounts to book value:
  • Shares of Citigroup closed at $41.83 Monday, returning 21% year-to-date, following a 44% decline during 2011. The shares trade for 0.8 times their reported June 30 tangible book value of $51.81, and for nine times the consensus 2013 EPS estimate of $4.53, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is $4.09. Citigroup's great unwind continues, with CEO Vikram Pandit saying on Tuesday that since forming its runoff subsidiary City Holdings, "we have reduced its assets by over $600 billion," including the announced deal to sell Citi's remaining stake in the Morgan Stanley Smith Barney joint venture to Morgan Stanley (MS).
  • Morgan Stanley is valued even more cheaply than Citi, with shares closing at $16.61 Monday, or 0.6 times their reported June 30 tangible book value of $27.70, and 8.5 times the consensus 2013 EPS estimate of $1.95. The consensus 2012 EPS estimate is 89 cents. Morgan Stanley's shares have returned 15% year-to-date, after dropping 44% during 2011.
  • Bank of America (BAC) closed at $8.58 Monday, returning 55% year-to-date, following last year's epic drop of 58%. The shares trade for 0.7 times their reported June 30 tangible book value of $13.22, and for nine times the consensus 2013 EPS estimate of 91 cents. The consensus 2012 EPS estimate is 55 cents. While the shares remain attractively valued even after the year-to-date run-up, BAC is still saddled with mortgage putback risk, with loan repurchase demands rising by 41% just in the second quarter, to $22.7 billion, as of June 30.

One of the reasons for the big discount for so many of the largest U.S. banks is the fear of continued regulatory onslaught, with various sources of fee income being pressured, the seemingly endless and agonizing implementation of the Volcker Rule's limits on "proprietary trading," heightened annual scrutiny through the Federal Reserve's stress tests and increasing capital requirements.

Some voices are still calling for the largest U.S. financial companies to be broken up, with no consideration of how this would make the Unites States much less competitive internationally, in an area where we have always been an innovator. Rochdale Securities analyst Richard Bove on Tuesday refuted the notion that the U.S. financial industry was "broken," by pointing out that during 2011, "Wells Fargo earned more than IBM ( IBM), Wal-Mart ( WMT), or General Electric ( GE)," and that "Citigroup was one of only 15 American companies that earned more than $10 billion in 2011" earning "more than Pfizer ( PFE), Google ( GOOG), or Coca Cola ( KO)."

Bove added that during 2011, " JPMorgan Chase ( JPM) made more money than all of the companies listed above."

Getting back to regional banks with strong growth prospects for investors, Sterne Agee on Monday updated its "Best Ideas" list of bank stocks, with the names being "well diversified among key sector themes ranging from solid organic growth to those delivering profitability improvement via credit leverage," according to Greene.

Here are the five buy-rated banks on Sterne Agee's "Best Ideas" list, with the greatest 12-month upside potential implied by the firm's price targets.

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