Buy SunTrust Now: Deutsche Bank

NEW YORK ( TheStreet) -- It's time for investors to buy shares of SunTrust ( STI), as the bank's coming cost savings from the housing recovery is not reflected in consensus earnings estimates, according to Deutsche Bank analyst Matt O'Connor.

O'Connor on Friday upgraded SunTrust of Atlanta to a "buy" rating from a "neutral" rating, while raising his price target for the shares to $39 from $36, saying in a note to clients that based on 2015 earnings estimates, the stock trades at "a 15% discount to peers."

The analyst raised his 2014 earnings estimate for SunTrust to $2.91 a share from $2.75, and raised his 2015 EPS estimate to $3.46 from $3.21.

A major theme for banks in the third quarter is the huge decline in mortgage refinancing applications, as long-term interest rates rise. This theme is expected to continue over the next year. According to its latest mortgage forecast, the Mortgage Bankers Association expects total mortgage refinance volume in the United States to decline from $1.247 trillion in 2012 to $973 billion in 2013 and $388 billion in 2014. The MBA expects total mortgage loan origination volume to fall from $1.750 trillion in 2012 to $1.592 trillion this year and $1.091 trillion in 2014.

Those are major declines, leading Wells Fargo ( WFC) recently to announce 2,300 layoffs of loan origination staff. Bank of America ( BAC) has also recently announced mortgage lending-related layoffs.

"Mortgage production revenue seems likely to decline sharply at STI and others," O'Connor wrote, "However, while production revs have been strong at STI in recent periods, STI's mortgage line-of-business overall has generated a net loss of $96m reflecting depressed servicing fees, elevated environment costs/operating losses and higher than normal other default servicing related costs (personnel related)."

The bottom line is that even though he expects SunTrust's mortgage origination revenue to decline by 50% by the end of the year, O'Connor expects the company's total mortgage revenue to decline by only 15% to 20%, as losses tied to soured loans decline.

Deutsche Bank's earnings estimates for SunTrust also factor in "a sharp rise in servicing fees (from $39m to $120m or from just 7bps of assets serviced (annualized) to 20bps) given a slowdown in amortization rates (as rates rise)."

Mortgage servicing assets are written down when long-term rates decline, since the likelihood of refinancing -- and a loss of servicing fees on the paid-off loans -- rises. When rates rise, the opposite happens.

O'Connor also estimates SunTrust will lay off roughly 900 staffers working on nonperforming loans and repossessed assets, for annual savings of roughly $150 million, "driving our higher EPS estimates."

SunTrust reported a second-quarter efficiency ratio of 66.56%, improving from 68.83% a year earlier. The efficiency ratio is, essentially, the number of pennies of overhead for each dollar of revenue. During the company's second-quarter conference call in July, SunTrust CFO Aleem Gillani said "We remain committed to achieving an approximate 65% efficiency ratio in 2013 and to our long-term target of below 60%."

O'Connor estimates that the long-term expense decline as the housing market recovers "is worth $150m annually or $0.20 per share and is not reflected in consensus estimates."

SunTrust's shares closed at $32.55 Thursday. The shares have returned 16% this year, following a return of 62% during 2012. The shares trade for 1.25 times their reported June 30 tangible book value of $26.08, and for 11 times the consensus 2014 EPS estimate of $2.97, among analysts polled by Thomson Reuters. The consensus 2015 EPS estimate is $3.32.

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Interested in more on SunTrust? 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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