Bank Stocks and the Secret of NIM (Update 2)

Updated with market close information, comments from FIG Partners analyst and Oppenheimer analyst Terry McEvoy on FirstMerit, and comments on Regions Financial from FBR analyst Paul Miller.

NEW YORK ( TheStreet) -- Bank stock investors need to look beyond declining net interest margins and focus on what really matters.

A bank's net interest margin (NIM) is the spread between the average yield on loans and deposits and the average cost for deposits and borrowings. With the Federal Reserve keeping its target range for the short-term federal funds rate in a range of zero to 0.25% since late 2008, the majority of banks have already seen most of the benefit they will realize on the cost side, while most continue to see their yields on earning assets decline.

Fig Partners analyst John Rodis says that "for most banks, there is just not much room for improvement on cost of funds," but the news isn't all bad.

"The one thing to remember when you talk about the margin is that even though the margin is down, it is just a ratio. It is very important to look at net interest dollars," Rodis says. "In a lot of cases, net interest income is coming down too, but it is certainly not coming down at the same pace as the margin."

FirstMerit Corp. ( FMER) of Akron, Ohio, is an example of a bank with net interest income declining at a slower pace than the net interest margin. The company on Monday reported a fourth-quarter NIM of 3.58%, declining from 3.66% in the third quarter. Net interest income was $119.1 million in the fourth quarter, declining 1.3% from $120.7 million the previous quarter.

FirstMerit's average core deposits -- excluding CDs and other time deposits -- grew by 1.1% during the fourth quarter to $10.173 billion, while the company's average loans -- excluding balances covered by Federal Deposit Insurance Corp. loss-sharing agreements -- grew 3.2% to $8.444 billion.

Still, Rodis on Wednesday downgraded FirstMerit to a "Market-Perform" rating from "Outperform," saying the stock was up 10% since it was upgraded in October. The analyst's target price for the shares is $16.00. Rodis lowered his 2013 earnings estimate for FirstMerit by five cents to $1.20 a share, to reflect "expectations for a lower margin and lower net interest income," although he also said he expected "core loan growth of 8-10% in 2013." Rodis also introduced a 2014 EPS estimate of $1.37.

Oppenheimer analyst Terry McEvoy on Tuesday stuck with his "Outperform" rating for FirstMerit, with an $18 price target, and said that "since it inked a deal to acquire MI-based Citizens Republic on September 13, 2012, FirstMerit's shares have fallen 10% compared to a 2% decline in the S&P Regional Bank index and a 4% gain in the S&P 500." McEvoy said that "in contrast to critics of the Citizens deal, we believe the assumptions behind the acquisition are conservative and that the combination will ultimately create a more valuable franchise."

McEvoy also pointed out that the company's total loans during the fourth quarter had grown at an annualized pace of 20%. The analyst estimates that First Merit will earn $1.35 a share in 2013.

First Merit's shares declined 2% on Wednesday to close at $15.18.

Regions Financial ( RF) is an example of a large regional bank bucking the net interest margin trend, as the company net interest margin widened slightly to 3.10% in the fourth quarter, while its net interest income also increased slightly to $818 million in the fourth quarter from $817 million in the third quarter.

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