Full Speed Ahead for Banks: Guggenheim

NEW YORK ( TheStreet) --Big U.S. banks can look forward to another year of strong recovery in 2013, according to Guggenheim Securities analyst Marty Mosby.

The analyst said in a report on Tuesday that "earnings per share growth remained above 20% in 2012 due to improvements in efficiencies and deployment of excess capital into discounted bank acquisitions and portfolio purchases." The market responded in a big way, sending the KBW Bank Index ( I:BKX) up 30% last year, and the index was up another 5% year-to-date, through Tuesday's market close.

According to Mosby, large-cap U.S banks "have recaptured about 75% of their prior peak in earnings per share." That's a rather impressive number when considering the massive scale of the credit mess and the slow pace of the economic recovery.

Covering the Cost of Equity


Large-cap banks' 2012 stock performance showed that investors were growing much more comfortable with banks' ability to manage credit losses. Looking ahead, investors will be looking for banks to improve their returns on tangible common equity (ROTCE), to cover and then exceed the cost of equity.

Guggenheim estimates that for the 18 large-cap banks that it covers, the median ROTCE for 2013 will be 12.5%, while the cost of equity will be 11.3%. Among the group, the median "excess return" over the cost of equity is projected to be 1.8%, and only half the group is expected by Guggenheim to generate excess returns.

The large-cap bank expected by Guggenheim to generate the highest excess return this year is U.S. Bancorp ( USB) of Minneapolis. The company has been among the strongest industry performers through and after the credit crisis. During 2012, USB's return on average common equity was a very strong 22.28%, according to Thomson Reuters Bank Insight. For 2013, Mosby estimates that USB's ROTCE will be 23.3%, against a cost of equity of 8.1%, for a fat excess return of 15.2%.

Mosby on Tuesday lowered his price target for USB to $41.00 from $42.00, but maintained his "buy" rating on the shares.

JPMorgan Chase analyst Vivek Juneja has a differing opinion on U.S. Bancorp, and on Jan. 30 lowered his rating on the shares to "neutral" from "overweight," saying that "USB's revenue growth is slowing and we expect the gap in revenue growth for USB to narrow versus peers." Juneja lowered his price target for the shares to $37.50 from $39.50 and lowered his 2014 earnings estimate to $3.30 a share from $3.37.

Mosby expects Bank of America ( BAC) to achieve a 2013 ROTCE of 8.1%, while its cost of equity will be 12.9%. For Citigroup ( C), he expects a 2013 ROTCE of 8.8%, with a cost of equity of 13.2%. These expected "negative excess returns" mean that over the short haul, these companies remain recovery plays for investors.

Bank of America and Citigroup are the only large-cap banks covered by Guggenheim still trading below tangible book value. Mosby has "buy" ratings on both companies and expects both to trade above tangible book by the end of the year. The analyst on Tuesday raised his price target for Bank of America to $15 from $14, and raised his target for Citi to $57.00 from $55.00.

Mosby said that for "investors with a preconceived viewpoint that the economy is picking up steam and should turn the corner in 2013 despite running off a fiscal cliff or two," the volatile Bank of America and Citigroup "represent more than 30% upside potential."

With both banks greatly boosting their capital, a major catalyst for the shares could be significant dividend increases after the Federal Reserve completes its annual bank stress tests in March. Both companies are currently paying nominal quarterly dividends of 1 cent a share. Guggenheim estimates that Bank of America's annual payout will rise 20 cents a share, while Citigroup's annual dividend will increase to $1.00.

Mosby said that his firm's dividend estimates "are based on the assumption that we believe it is in management's best interest to use all of their excess capital to increase their dividends instead of repurchasing shares." Of course, the banks' management could decide otherwise.

Oppenheimer analyst Chris Kotowski cautioned investors on Monday "to have guarded expectations" for dividend increases following the stress tests. He estimates that Bank of America's annual dividend for 2013 will be just 12 cents a share, while Citigroup's will be 40 cents, with neither of the companies buying back any shares. While both companies "have high and rising capital ratios, the industry's recent history suggests that the banks get let out of the penalty box only very slowly," he said.

Upgrading BB&T


Mosby on Tuesday upgraded BB&T ( BBT) of Winston-Salem, N.C., to a "buy" rating from a "neutral" rating, while increasing his price target for the shares to $38.00 from $34.00. The analyst also raised his 2013 EPS estimate for the shares to $3.10 from $3.09, while lowering his 2013 estimate to $3.50 from $3.56.

BB&T last month raised its quarterly dividend to 23 cents a share from 20 cents, for a yield of 3.01%, based on Monday's closing price of $30.52. Mosby said that his price target reflects "the strength of BBT's dividend yield," following the stress tests. "We believe BBT's dividend yield could reach as high as 3.3%, as compared to its current stock price," he said, with an annual payout of $1.00 a share.

Guggenheim estimates BB&T will achieve a 2013 ROTCE of 17.6%, with a cost of equity of 9.3%, for an excess return of 8.3%.

Stifel Nicolaus analyst Christopher Mutascio has lower expectations for BB&T, rating the shares "neutral," with a 2013 EPS estimate of $2.88 and a 2014 EPS estimate of $3.10. Mutascio said in a report on Jan. 22, that with both BB&T and U.S. Bancorp trading at roughly 10 times his firm's 2014 EPS estimates, "investors do not seem to be differentiating between the profitability levels of each bank. For investors looking to increase their exposure to higher quality/highly profitable banks by taking off some risk exposure amid the recent run in bank stocks, we prefer USB over BB&T at current levels."

Another "Top Pick"


Wells Fargo ( WFC) and Citigroup are Mosby's "current top picks" among large-cap banks, as "both have better than twice the amount of upside potential as the median" for the group. Mosby on Tuesday raised his price target for Wells Fargo's shares to $46.50 from $43.00, while raising his 2013 EPS estimate to $3.90 from $3.89 and lowering his 2014 EPS estimate to $4.30 from $4.40.

Guggenheim estimates that Wells Fargo's 2014 ROTCE will be 17.4%, with a cost of equity of 9.5%, for an excess return of 7.9%.

Wells Fargo in January raised its quarterly dividend to 25 cents from 22 cents, for a yield of 2.88%, based on Tuesday's closing price of $34.76.

"We estimate WFC's dividend yield post this year's stress test process could bounce up to 3.5%, possibly attracting yield and value investors back into the stock," Mosby said. Guggenheim estimates that the dividend payout for 2013 will be $1.20 a share.

Atlantic Equities analyst Richard Staite has a less optimistic view on Wells Fargo's prospects this year, and downgraded the shares to a "neutral" rating from "overweight" on Jan. 16, because of expected pressure on the company's mortgage revenue and net interest margin. Please see TheStreet's Short-Term Mortgage Pain Is Long-Term Gain for Banks for more on the industry's margin pressure and the effect of rising long-term rates on banks' mortgage revenue.

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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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