Margin Pressure and Mortgage Pressure
The central bank has kept the short-term federal funds rate in a target range of zero to 0.25% since late 2008, and the Federal Reserve Open Market Committee on Wednesday said it would continue its purchases of $85 billion a month in long-term securities. Last year this expansion of the Fed's balance sheet was tempered through the sale of $45 billion a month in shorter-term U.S. Treasuries, but those sales have ended. The Open Market Committee has also said that the "exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5%," assuming that inflation is kept in check. A bank's net interest margin (NIM) is the spread between the average yield on loans and securities investments and the average cost for deposits and borrowing. With most banks already realizing most of the benefit on the cost side, margins are getting squeezed as assets continue to reprice at lower rates. Still, many regional banks have been successful in tempering the blow to net interest income by boosting commercial loan portfolios. Usdin said in a report late Wednesday that "we feel better about estimate sustainability (particularly for larger regionals), but struggle to find much EPS growth through 2014." The analyst noted that for the regional banks covered by his firm, total loans grew 2% sequentially during the fourth quarter, as commercial and industrial lending "ended the year on a high note." Still, he said few investors were "willing to believe it." "We attribute some of the strength to tax planning and are therefore hesitant to revise our loan growth estimates meaningfully higher," he said.
A "Rate Trade"
So where's the silver lining for investors? Usdin said that with the rise in the yield on 10-year Treasuries, "bank stocks are moving again in anticipation of higher rates." "While we continue to believe the Fed will remain committed to its current course and rates will not move until 2015, we recognize that sentiment could hold sway in investors' minds." Some investors may expect to see a faster and sharper increase in short-term rates, and truly long-term investors who can commit for several years may eventually see a tremendous benefit from a friendlier rate curve. Usdin listed the regional banks that Jefferies would expect to see the most significant increase in earnings if short-term rates rose by 200 basis points, based on detailed balance sheet data from third-quarter 10-Q filings. Here are the top three from that list, with projections based on the firm's 2013 earnings estimates:
- Jefferies estimates that PrivateBancorp (PVTB) of Chicago will earn $1.25 a share this year without any action by the Fed to raise short-term rates. Based on that estimate, Usdin said the company's EPS would rise by 58% to $1.97 if short-term rates rose by 200 basis points.
- For Zions Bancorporation (ZION), Jefferies estimates 2013 EPS of $1.60. If short-term rates were to rise by 200 basis points, Usdin estimates the company's earnings would rise by 45% to $2.32 a share.
- Jefferies is estimating that SVB Financial Group (SIVB) of Santa Clara, Calif., will earn $3.75 a share in 2013. If short-term rates were to rise by 200 basis points, Usdin estimates that the company's EPS would increase by 40% to $5.26.
Downgrading Four Regional Banks
BernsteinResearch analyst Kevin St. Pierre on Thursday said "we believe any optimism around the potential impact of higher rates is premature and overstated." The analyst also said that "after significant outperformance in 2012, we believe the U.S. regional banks appear, on average, modestly overvalued when viewed against forward earnings power."
- Comerica (CMA) of Dallas. St. Pierre called the company "the poster child for asset sensitivity," as "roughly 65% of assets are tied to the short end of the yield curve and will reprice quickly when rates rise." While calling the shares attractively valued to "normalized earnings," the analyst said that the stock appears "quite expensive" to Bernstein's EPS estimates of $2.70 for 2013 and $2.80 for 2014. Bernstein's price target for the shares is $27.
- KeyCorp (KEY) of Cleveland. "KEY is also quite asset-sensitive," according to St. Pierre, with about 46% of assets set to reprice during 2013. The analyst said that "on 2013-2014 EPS, the stock appears rich." Bernstein's price target for the shares is $8, with a 2013 EPS estimate of 89 cents, increasing to 90 cents for 2014.
- Regions Financial (RF) of Birmingham, Ala. St. Pierre said the stock is currently trading at a forward price-to-earnings ratio of 93% to his firm's 2014 EPS estimate, when compared to the forward P/E for the S&P 500 (SPX.X). Bernstein's price target of $7 "represents a 75% relative P/E (versus the S&P 500) on our 2014 EPS estimate of $0.74," which matches the long-term average relative to the index. The firm's 2013 EPS estimate is 76 cents.
- Zions Bancorporation. "Among the 'asset-sensitive' names, we believe ZION will be the long-term winner," St. Pierre said, "as it possesses many of the underlying qualities we like to see in a regional bank." But the analyst said the shares are "quite expensive" relative to his firm's 2013 EPS estimate of $1.84 and the 2014 EPS estimate of $1.86. Bernstein's price target for the shares is $20.
Email. Follow @PhilipvanDoorn