3 Top Picks in Regional Banks: Oppenheimer

NEW YORK ( TheStreet) -- Regional banks are relying on expense cuts to meet earnings estimates, which "makes it difficult to argue for multiple expansion across the sector," according to Oppenheimer analyst Terry McEvoy.

The clear trend for regional banks in the first quarter was significant cuts in credit and overhead expenses offsetting plenty of revenue pressure, including narrowing net interest margins, a decline in mortgage loan applications and lower gains on the sale of mortgage loans. This enabled most of the regionals to meet consensus earnings estimates, but also signaled pressure for bank stocks through the rest of 2013.

Earnings estimates are very important to investors, as revisions to the estimates can drive stock prices, especially if there is a trend of similar revisions among many analysts. There has been an upward trend for several years for earnings estimates, as analysts have correctly anticipated a decline in credit-related expenses and the release of loan loss reserves, as the industry recovers from the real estate crisis.

But that trend appears to be over, at least for now.

"Consensus estimates did not change on average post 1Q13 earnings," McEvoy wrote in note to clients late on Monday, "however, we now see lower-quality earnings with reduced revenue forecast offset by the new lower run-rate of estimates."

For the largest 100 regional and small banks by total assets, total revenue declined by $1.0 billion in the first quarter from the fourth quarter, with expenses declining by $1.5 billion, according to McEvoy. The decline in revenue was "split evenly between net interest and fee income as bank and mortgage spreads compressed in the quarter," he wrote.

Net interest margins continue to be pressured, with the Federal Reserve keeping the short-term federal funds rate in a range of zero to 0.25% since late 2008, while the central bank has recently been making monthly purchases of $85 billion in long-term securities, in an effort to hold long-term rates down. So most banks have already enjoyed most of the benefit from declining funding costs, while their assets continue to reprice at lower rates.

Jefferies analyst Ken Usdin made similar comments in a report on Monday, saying that 2013 and 2014 earnings estimates "held up, but in a low quality way. Revenue forecasts were revised lower in most cases and better credit and expenses made up the difference." Usdin added that with regional bank stocks on average trading for 12.7 times 2014 earnings estimates, "the group is reasonably valued, but it is tough to argue that estimates have floored, given lackluster revenue trends."

In a report on Tuesday, Citigroup analyst Josh Levin wrote "the stability in headline consensus EPS is deceptive," adding his team's research "suggests that investors are paying roughly the same multiple for lower quality earnings streams which have greater likelihoods of downward revisions than they did previously."

Despite the depressing focus on cost-cutting rather than revenue growth, McEvoy said Oppenheimer's "top picks" among bank stocks "remain those banks with additional opportunities for expense and/or deposit cost reductions . . . and ones where believe consensus is too low."

Here are the three top Oppenheimer regional bank stock picks rated "outperform," in order of ascending upside to the firm's price targets:

FMER Chart FMER data by YCharts

3. FirstMerit

Shares of FirstMerit ( FMER) of Akron, Ohio, closed at $17.04 Monday, returning 21% this year, following a 2% decline during 2012. The shares trade for 1.6 times tangible book value, according to Thomson Reuters Bank Insight, and for 12.0 times the consensus 2014 earnings estimate of $1.42 a share. The consensus 2013 EPS estimate is $1.29.

Based on a quarterly payout of 16 cents, the shares have a dividend yield of 3.76%.

FirstMerit on April 12 completed its acquisition of Citizens Republic Bancorp of Flint, Mich., bringing on over $9.5 billion in assets and over 170 branches. The company had a total of 415 branches in Ohio, Michigan, Wisconsin, Illinois and Pennsylvania as of March 31, with $15.3 billion in total assets.

FirstMerit reported first-quarter earnings of $37.3 million, or 33 cents a share, compared to $38.3 million, or 35 cents a share, in the fourth quarter, and $35.0 million, or 32 cents a share, in the first quarter of 2012.

Net interest income declined to $114.4 million in the first quarter from $119.2 million the previous quarter and $120.7 million a year earlier, however, the sequential decline was more than offset by a decline in expenses.

Noninterest expenses totaled $106.9 million in the first quarter, declining from $112.2 million in the fourth quarter and $119.1 million in the first quarter of 2012.

The company's first-quarter return on average assets was 1.01% and its return on average common equity was 8.83%.

McEvoy said in a report on April 23 that "we see potential upside to earnings from the recently closed acquisition of Citizens Republic as the Michigan economy grows, and feel confident in management's ability to integrate the two companies."

The analyst's 12-to-18-month price target for FirstMerit is $18, and he estimates the company will earn $1.38 a share this year, with EPS rising to $1.40 in 2014.

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

PVTB Chart PVTB data by YCharts

2. PrivateBancorp

Shares of PrivateBancorp ( PVTB) of Chicago closed at $19.14 Monday, returning 25% this year, following a 40% return during 2012.

The shares trade for 1.3 times tangible book value, and for 13.3 times the consensus 2014 EPS estimate of $1.44. The consensus 2013 EPS estimate is $1.36.

The company reported first-quarter net income available to common stock holders of $27.3 million, or 35 cents a share, increasing from $20.0 million, or 26 cents a share, in the fourth quarter, and $10.8 million, or 15 cents a share, in the first quarter of 2012.

Net interest income for the first quarter was $103.0 million, declining from $104.8 million the previous quarter and $104.4 million a year earlier. PrivateBancorp's net interest margin for the first quarter was 3.19%, widening slightly from 3.16% in the fourth quarter, but narrowing from 3.53% in the first quarter of 2012.

The main factor in PrivateBancorp's significant earnings improvement has been a decline in credit costs. The company's first-quarter provision for loan losses was $10.4 million, declining from $13.2 million the previous quarter and $27.7 million a year earlier. The company also saw a decline in costs to maintain foreclosed real estate to $6.6 million in the first quarter from $9.6 million in the fourth quarter and $8.2 million in the first quarter of 2012.

In a note to clients on April 18, McEvoy wrote that "the transition from credit recovery to growth is firmly under way," and that "earnings in '13 will continue to benefit from lower credit and real estate-related costs.

"While many small-cap banks are struggling with earnings growth, we forecast EPS growth of 10% in '14," McEvoy wrote, adding that "this should translate into a higher valuation for PVTB, supporting our $21 price target."

McEvoy estimates PrivateBancorp will earn $1.32 a share this year, with earnings increasing to $1.45 a share in 2014.

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

KEY Chart KEY data by YCharts

1. KeyCorp

Shares of KeyCorp ( KEY) of Cleveland closed at $9.91 Monday, returning 18% this year, following a 12% return during 2012. The shares trade just above tangible book value, and for 10.3 times the consensus 2014 EPS estimate of 96 cents. The consensus 2013 EPS estimate is 88 cents.

The company on April 18 announced the estimated after-tax gain on its pending sale of Victory Capital Management and Victory Capital Advisors would be in the range of $145 million and $155 million. The sale is expected to be completed in the third quarter.

KeyCorp in March announced that the Federal Reserve had approved its plan for share repurchases of up to $426 million through the first quarter of 2014, and that it had been approved to apply the gain on the Victory Capital sale toward additional repurchases.

The company was granted approval to raise its quarterly dividend on common shares to 5.5 cents from 5 cents, subject to board of directors approval, which is expected in May. Based on the current payout, the shares have a dividend yield of 2.02%.

KeyCorp reported first-quarter net income from continuing operations attributable to common shareholders of $196 million, or 21 cents a share, increasing from $190 million, or 20 cents a share, in the fourth quarter, and $195 million, or 20 cents a share, in the first quarter of 2012.

The company said it expected its "Fit for Growth" cost-cutting plan to produce annual savings of $200 million by the end of 2013.

Please see TheStreet's earnings coverage for a detailed review of KeyCorp's first quarter results.

McEvoy on April 18 reiterated his $11 price target for KeyCorp, saying in a note to clients that "while boring on the surface, KeyCorp remains in strong position to outperform its peers as the company successfully reduces operating expenses and repurchases shares."

"We see positive earnings growth in '14 and believe the stock remains undervalued at under 10x our '14 estimate and 0.97x tangible book value," he wrote.

McEvoy estimates KeyCorp will earn 87 cents a share this year, with EPS rising to $1.00 in 2014.

Interested in more on KeyCorp? 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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