Buy Huntington Bancshares for Solid Rate Play: Merrill Lynch

Updated from 11:54 a.m ET with afternoon market action and Huntington's interest rate shock analysis showing benefits of rising rates.

NEW YORK ( TheStreet) -- Huntington Bancshares ( HBAN) is an excellent play for investors looking for a bank stock that will benefit when short-term rise, according to Bank of America Merrill Lynch analyst Erika Penala.

In a report on Thursday, Penala wrote that in light of the recent spike in market rates for 10-year U.S Treasury bonds, her research team updated its proprietary rate scorecard for banks. The analysts found that the regional banking names covered by their firm that would see the greatest earnings benefit from an increase in short-term rates included Zions Bancorporation ( ZION), Comerica ( CMA), KeyCorp ( KEY), Huntington and Fifth Third Bancorp ( FITB).

Penala has neutral ratings on all the above names, except for Huntington Bancshares of Columbus, Ohio, which she rates a "buy," because the stock's valuation is "still reasonable," amid a strong rally for bank stocks. Her price target for the shares is of $8.00.
Huntington CEO Stephen Steinour

Huntington's shares closed at $7.71 Wednesday, returning 21% this year, following a 20% during 2012. The shares trade for 1.3 times their reported March 31 tangible book value of $5.91, and for 11.0 times the consensus 2014 earnings estimate of 70 cents a share, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is 67 cents.

Based on a quarterly payout of five cents, the shares have a dividend yield of 2.59%. Huntington's board of directors in April approved a $227 million share buyback plan.

Huntington's shares were up 3% in afternoon trading, to $7.91.

While including Huntington as the only buy-rated name among covered regional banks best-positioned for rising short-term rates Penala also said that Huntington was among two regional banks "best positioned to defend" their net interest margins, also including Capital Bank Financial ( CBF) of Coral Gables, Fla., which she also rates a "buy," with a price target of $23.00.

Defending the Net Interest Margin

The Federal Reserve has kept the short-term federal funds rate in a range of zero to 0.25% since later 2008. Since September, the central bank has 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 seen the bulk of the benefits from lower funding costs, while their assets have continued to reprice lower. This has led to net interest margin pressure for most banks. The margin is the spread between the average yield on loans and investments and the average cost for deposits and borrowings.

Huntington Bancshares reported first-quarter net income of $151.8 million, compared to $167.3 million, or 19 cents a share, in the fourth quarter, and $153.3 million, or 17 cents a share, in the first quarter of 2012. The main factor in the earnings decline was lower mortgage banking income, which totaled 45.2 million in the first quarter, compared to $61.7 the previous quarter and $46.4 million a year earlier.

Huntington's first-quarter net interest income was $430.1 million, declining from $439.5 million the previous quarter, but increasing from $421.1 million a year earlier. The sequential decrease in net interest income mainly resulted from a lower number of days in the quarter, although the net interest margin narrowed to 3.42% in the fourth quarter from 3.45% in the fourth quarter. The margin was unchanged from a year earlier.

The year-over-year net interest income growth reflected a 4% increase in in average loans and leases, with commercial and industrial loans growing 14% to $17 billion in the first quarter. Meanwhile, average interest-bearing liabilities were down slightly year-over-year. Average noninterest bearing checking account grew 8% year-over year to $12.2 billion, although they were down 7% from the fourth quarter, because of the bank's "effort to reduce collateralized deposits," and because of "a recent uptick among our business customers of drawing down cash balances to support working capital needs," according to comments by CEO Stephen Steinour in the company's earnings press release.

Speaking at a conference on Thursday, Steinour said Huntington's "net interest margin is down 5 basis points over the last 3 years, while the peer average is down over 20 basis points."

"Our growth in non-interest bearing deposits has helped us re-mix the balance sheet very significantly, providing one of the key factors that allowed us to maintain, generally maintain, our net interest margin, despite pressures from the yield curve," he said.

Looking ahead, Steinour said "I think what we're likely to see is that the asset yield pressures will, frankly, abate," meaning that the market will drive loan rates higher, as securities yields continue to rise. He also expects Huntington to continue to benefit from its focus on building multiple relationships with each customer, to drive a continued increase in noninterest-bearing checking accounts.

The Federal Open Market Committee has repeatedly said it was likely to leave the federal funds rate in its current range at least until the U.S. unemployment rate moves below 6.5%. But top FOMC and Federal Reserve officials have given conflicting statements recently about the timing of a curtailment of the Fed's bond-buying. The market always anticipates monetary policy changes, and the recent rise in market rates on the 10-year could signal a policy change in the near-term.

In its quarterly 10-Q filing with the Securities and Exchange Commission, Huntington said a 200 basis-point parallel shift in long and short-term interest rates would increase its net interest income by 3.1%, based on its first-quarter numbers.

A Balanced Rate play

"For investors looking to add 'rate sensitive' names, we would point to HBAN, a less recognized rate sensitive bank which in our view trades at a reasonable absolute P/E (10.5x) and a discounted relative P/E (0.75x) to peers, and offers relative margin defensibility today," Penala wrote.

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

-- Written by Philip van Doorn in Jupiter, Fla.

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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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