5 Banks Stocks Showing 'Real' Earnings Growth

NEW YORK ( TheStreet) -- Yes, it was a difficult third-quarter bank earnings season, and the fourth-quarter is expected to be even worse.However, many banks have grown their earnings considerably over the past few years.

Two of the main challenges to the industry have been widely covered. First is the pressure on the net interest margin, which is the difference between a bank's average yield on loans and investments and its average cost for deposits and borrowings. With the Federal Reserve keeping its target federal funds rate in a range of zero to 0.25% since the end of 2008, most banks have already seen all the benefit on the interest expense side that they are likely to see. Meanwhile, the central bank in September expanded its purchases of long-term mortgage-backed securities by $40 billion a month -- known as QE3 -- in an attempt to push long-term rates lower, or at least keep them at their historically low levels.

Banks are also expected to see a sharp decline in commercial and industrial loan origination during the fourth quarter. Before this year's boom in residential loan refinancing, C&I lending was a bright spot for the industry. FBR analyst Paul Miller said last week that commercial borrowers are entering into new agreements for bank credit lines, but "but they are not borrowing the money," as they keep their expansion powder dry and wait for the election results and for Congress to compromise on the "fiscal cliff."

The fiscal cliff could cause the income tax cuts -- including the 15% maximum tax rate on qualified dividends -- signed into law by President George W. Bush and extended by President Obama in 2010, to expire as part of the 2010 budget compromise. Unless a fiscal cliff deal is worked out, there will be mandatory federal spending cuts, along with the tax increases, which the Congressional Budget Office and many economists think will send the U.S. economy back into recession.

Moving past the gloom and doom, many banks grew their earnings sequentially and year-over-year during the third quarter, and not just from credit quality improvement and the release of loan loss reserves.

Banks typically add to their loan loss reserves each quarter, which is called the "provision" for reserves. If the provision is negative, or if it is less than the dollar amount of loans charged-off during the quarter, the bank has "released" reserves. In order to keep banks from "managing" their earnings by manipulating their quarterly provisions for reserves when credit quality is strong, regulators frown on banks "over-reserving" during the good times, and may even force banks to over-reserve during an economic downturn.

With the general improvement in credit quality as we move through the slow economic recovery, most large banks have been seeing quite an earnings boost from the release of loan loss reserves over the past two years.

Using the partial set of third-quarter data that is now available , we have identified five banks that have significantly grown their pre-provision net revenue.

Pre-provision net revenue is calculated by adding a bank's net interest income -- tax-adjusted if possible -- to its non-interest income, and subtracting its noninterest expense.

Using this approach can lead to some rather extreme results, with one-time items affecting one quarter's earnings, so we have narrowed the sample to include only companies that were profitable, with positive operating returns on average assets (ROA) for the past five quarters, and companies that also saw their pre-provision net revenue grow quarter-over-quarter.

Two of the "big four" U.S. banks have seen their pre-provision net revenue grow significantly over the past year:
  • Wells Fargo (WFC) saw its pre-provision net revenue -- backing out gains on equity investments and gains on debt securities available for sale -- grow 13% year-over-year, to $9.1 billion in the third quarter, according to Thomson Reuters Bank insight. While third-quarter tax-adjusted net interest income declined to $10.10.820 million from $10.714 million a year earlier, noninterest income rose to $10.384 billion from $8.442 billion, and noninterest expense declined by over $1 billion to $12.112 billion. Mortgage banking revenue was up 53% year-over-year to $2.807 billion in the third quarter, while the company reported net gains from trading activities of $529 million, compared to losses of $442 million, a year earlier. Overall earnings performance remained strong, with a third-quarter ROA of 1.45% and a return on equity of 13.38%.
  • For JPMorgan Chase (JPM), pre-provision net income increased 14% year-over-year to $10.317 billion. The company's tax-adjusted net interest income declined to $11.176 billion in the third quarter from $11.950 billion a year earlier, as the company's net yield narrowed by 23 basis points year-over-year, to 2.43%. But the company's third-quarter noninterest income -- backing our securities gains -- increased to $13.712 billion from $11.339 billion in the third quarter of 2011. JPMorgan's Corporate/Private Equity business line saw profit increasing to $221 million in the third quarter, from a loss of $645 million a year earlier. Meanwhile, Retail Financial Services profit grew 21% year-over-year, to $1.408 billion, amid the wave of mortgage loan refinancing.
  • Citigroup (C) saw a 22% year-over-year decline in pre-provision net revenue, to $5.887 billion in the third quarter. Third-quarter tax-adjusted net interest income declined to $12.054 billion from $12.252 billion a year earlier, reflecting a decline in earning assets, as part of the company's long-term strategy to right-size its balance sheet. Citi's net interest margin actually expanded, to 2.86% in the third quarter, from 2.83% a year earlier. Noninterest income declined to $6.237 billion in the third quarter from $8.098 million a year earlier. The third-quarter bottom-line results included a pre-tax loss of $4.7 billion from the sale of a 14% interest in the Morgan Stanley Smith Barney joint venture and the write-down on Citi's remaining 35% interest in the joint venture, which will eventually be sold to Morgan Stanley (MS). A major positive for Citigroup an estimated Basel III Tier 1 common equity ratio was strong 8.6% as of Sept. 30, giving investors hope that the company could receive Federal Reserve approval for a significant return of capital during 2013.
  • For Bank of America (BAC), one-time items brought the company's third-quarter pre-provision net revenue down by 55% year-over-year, to $4.380 billion in the third quarter. Third-quarter results included pretax litigation expenses totaling $1.6 billion, including the settlement of a 2009 class action lawsuit, related to the company's acquisition of Merrill Lynch. Bank of America's net interest income declined to a tax-adjusted $10.167 billion in the third quarter, from $10.739 billion a year earlier. Noninterest income was down 36% year-over-year, to $10.157 billion in the third quarter, in part because the third-quarter 2011 results included a $3.6 billion gain on sales of shares in China Construction Bank, which was partially offset by a loss of $2.2 billion on private equity and other investments, including the CCB stake.

Applying the criteria listed above, the following is a sample of five banks very strong year-over-year growth in pre-provision net revenue, counting up to the one with the most growth:

5. Wintrust Financial
Shares of Wintrust Financial ( WTFCO) of Lake Forest, Ill., closed at $37.07 Friday, returning 33% year-to-date, following a 15% decline during 2011.

Wintrust's shares trade for 1.3 times their reported Sept. 30 tangible book value of $28.93, and for 15 times the consensus 2013 earnings estimate of $2.47 a share, among analysts polled by Thomson Reuters.

During the third quarter, Wintrust purchased the failed First United Bank of Crete, Ill., and Second Federal Savings and Loan Association from the Federal Deposit Insurance Corp. The company in September agreed to acquire HPK Financial Corp. of Hyde Park, Ill, which has about $390 million in total assets, in a deal that is expected to be completed in the fourth quarter.

Wintrust had $17 billion in total assets as of Sept. 30. The company's third-quarter pre-provision net revenue -- aside from bargain purchase gains on acquisitions and gains on available-for-sale securities -- grew by 23% from a year earlier to $63.9 million, reflecting a 12% increase in net interest income to $132.6 million, from strong loan growth, while the net interest margin bucked the industry trend and expanded to 3.55% from 3.38% in the third quarter of 2011. Excluding bargain purchase gains booked after failed-bank acquisitions in both periods and gains on securities available for sale, Wintrust's noninterest income grew 41% year-over-year, to $55.9 million in the third quarter. The bulk of this improvement was mortgage banking income, which totaled $31.1 million in the third quarter, increasing from $14.5 million a year earlier. Noninterest expense was up 17% year-over-year, to $124.6 million.

Third-quarter earnings were $32.3 million, or 66 cents a share, increasing from $30.2 million, or 65 cents a share, in the third quarter of 2011. The company's second-quarter ROA was 0.77% and its return on average common equity was 7.57%.

Jefferies analyst Emlen Harmon reiterated his "Hold" rating for Wintrust on Oct. 18, after the company reported its third-quarter results, saying "concerns about the longer-term earnings run-rate surfaced as a portion of outsized expense growth will be run-rated. We remain cautious on the shares, as the roll-off of mortgage revenue and modest margin compression weigh on the company's ability to generate significant earnings growth post-4Q.

Harmon has a $35 price target for Wintrust's shares, and estimates the company will earn $2.50 a share in 2013.

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

4. M&T Bank
Shares of M&T Bank ( MTB) of Buffalo, N.Y., closed at $103.44 Friday, returning 39% year-to-date, following an 8% decline last year.

M&T's shares trade for 2.4 times tangible book value, according to Thomson Reuters Bank Insight, and for 13 times the consensus 2013 EPS estimate of $8.14.

Based on a quarterly payout of 70 cents, the shares have a dividend yield of 2.71%.

M&T had $81.1 billion in total assets as of Sept. 20. The company August agreed to acquire Hudson City Bancorp ( HCBK) of Paramus, N.J., for $3.7 billion in stock and cash. Hudson City had $41.9 billion in total assets as of Sept. 30, and its board of directors had been some pressure to sell, after a long-term leverage strategy of increasing wholesale borrowings and investing in long-term mortgage-backed securities backfired in the prolonged low-rate environment, leading to two costly balance sheet restructurings. The merger is expected to be completed during the second quarter of 2013.

For the third quarter, M&T's pre-provision net revenue grew 38% year-over-year, to $504.3 million, with mortgage banking revenue of $106.8 million, increasing from $38.1 million in the third quarter of 2012. Meanwhile, third-quarter noninterest expenses totaled $616.0 million, declining from $ $662.0 a year earlier, with the cost savings "predominantly due to the integration of the operations obtained in the May 2011 acquisition of Wilmington Trust Corporation."

M&T's tax-adjusted net interest income grew 7% year-over-year to $669.3 million in the third quarter, and the net interest margin widened to 3.75% from 3.67% a year earlier.

M&T reported third-quarter net income available to common shareholders of $273.9 million, or $2.18 a share, increasing from $1.32 during the third quarter of 2011. The company's third-quarter ROA was 1.45% and its return on average common equity was 12.40%.

Jefferies analyst Ken Usdin rates M&T a "Hold," with a price target of $106, saying on Oct. 24 that because Hudson City's third-quarter results showed "incremental loan yield compression and lower interest income," he was lowering his 2013 earnings estimate for M&T by a nickel to $8.40. Usdin added that "there are a ton of moving parts and as much as three full quarters left before closing, so a lot could change otherwise."

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Interested in more on M&T Bank? See TheStreet Ratings' report card for this stock.

3. Capital One
Shares of Capital One Financial ( COF) of McLean, Va., closed at $60.00 Friday, returning 42% year-to-date, following a flat return during 2011.

The shares trade for 1.5 times their reported Sept. 30 tangible book value of $40.17, and for 8.5 times the consensus 2013 EPS estimate of $7.05.

Following "messy" first and second quarters, from one-time items related to the acquisitions of ING Direct (USA) in the first quarter and HSBC's U.S. credit card portfolio in the second quarter, Capital One reported third-quarter earnings available to common shareholders of $1.2 billion, or $2.01 a share (excluding income from discontinued operations), increasing from $813 million, or $1.77 a share, during the third quarter of 2011.

The company's third-quarter ROA was 1.60% and its return on average equity was 12.33%. The return on average tangible equity was 21.48%.

Capital One's second-quarter pre-provision net revenue grew 45% year-over-year, to $2.8 billion. Net interest income was up 42% to $4.6 billion, while the net interest margin narrowed to 6.97% from 7.39%.

Noninterest income increased 30% year-over-year, to $1.1 billion, while noninterest expense grew 33% to $3.0 billion.

Oppenheimer analyst Chris Kotowski on Oct. 19 said that Capital One "crushed it," beating his third-quarter EPS estimate of $1.63, although there were "complicated purchase accounting impacts and moving parts that keep us from simply multiplying the $2.01 by four to estimate 2013."

Kotowski rates Capital One a "Buy," and said that "investors are yearning for two comparable quarters from COF, and this wasn't it. However, while we are once again left with an unease about all the moving parts, a $7+ number in 2013 seems very reasonable to us, and our target for the stock is now $71."

Kotowski's price target for Capital One is $68.00, and he estimates that Capital One will earn $7.02 a share in 2013.

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

2. City National
Shares of City National Corp. ( CYN) of Los Angeles close at $50.56 Friday, returning 16% year-to-date, following a 27% declined last year.

The shares trade for 1.6 times tangible book value, and for 13 times the consensus 2013 EPS estimate of $3.96.

Based on a quarterly payout of 25 cents, the shares have a dividend yield of 1.98%.

City National in July purchased Rochdale Investment management.

The company had $26.3 billion in total assets as of Sept. 30. Third-quarter pre-provision net revenue grew 52% year-over-year, to $108.5 million. Noninterest income -- excluding investment gains -- was up 61% year-over-year to $106.4 million, as City National booked $1.7 million in revenue from FDIC loss-sharing agreements, when the company had reported $14.2 million in expenses from the agreements a year earlier. Trust and investment fees rose to $43.5 million in the third quarter from $35.4 million in the third quarter of 2011, while brokerage and mutual fund fees increased to $9.1 million from $5.1 million, reflecting the Rochdale acquisition.

City National's third-quarter net interest income was up 5% from a year earlier, to $209.9 million, but the net interest margin narrowed to 3.52% from 3.74%.

The company reported third-quarter net income of $59.8 million, or $1.10 a share, increasing from $41.4 million, or 78 cents a share, a year earlier. City National's third-quarter ROA was 0.93% and its return on average equity was 10.35%.

Jefferies analyst Casey Haire rates City National a "Hold," with a $52 price target, and said on Oct. 19 that "we leave our 2013 EPS estimate intact at $3.95 as a stronger-than-expected contribution from Rochdale is offset by a weaker net interest income forecast," that that the outlook for net interest income "is flat at best given thinning capital ratios, which limit CYN's ability to outrun net interest margin compression via balance sheet growth."

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

1. Brookline Bancorp
Shares of Brookline Bancorp ( BRKL) of Brookline, Mass., closed at $8.48 Friday, returning 3% year-to-date, following 19% decline during 2011.

The shares trade for 1.3 times tangible book value, and for 13 times the consensus 2013 EPS estimate of 67 cents.

With a quarterly payout of 8.5 cents, the shares have a dividend yield of 4.01%.

Brookline Bancorp had $5.1 billion in total assets as of Sept. 30. The company's pre-provision net revenue grew by 58% year-over-year to $19.8 million in the third quarter, as its net interest income increase by 68% to $46.4 million, mainly because of the acquisition of Bancorp of Rhode Island in January. The net interest margin widened to 4.00% in the third quarter, from 3.68% a year earlier.

The company's noninterest income increased to $3.8 million in the third quarter from $928 million a year earlier. Noninterest expense nearly doubled, to $30.4 million.

Brookline reported third-quarter earnings of $11.4 million, or 16 cents a share, increasing from $6.3 million, or 11 cents a share, a year earlier. The third-quarter ROA was 0.90% and the return on average equity was 7.53%.

KBW analyst Damon DelMonte rates Brookline Bancorp "Market Perform," with a $9.00 price target, and said on Oct. 24 after the earnings announcement that "BRKL posted a solid quarter as the bank's bottom line benefited mainly from liquidity deployment into loans and securities and a lower tax rate from federal tax credits, both of which were somewhat offset by higher expenses across the board."

DelMonte added that the company's core net interest margin "expansion was closer to 5bps as the reported NIM benefited from 14bps, or $1.4mm, of yield adjustments on the bank's acquired loan portfolio" from the Bancorp of Rhode Island acquisition.

DelMonte estimates that Brookline Bancorp will earn 65 cents a share during 2013.

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

-- 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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