5 Lean and Mean Bank Stocks

NEW YORK ( TheStreet) -- Yes, the government is shutting down, but after Congress and President Obama settle on a budget and again raise the federal debt ceiling, bank executives will still be talking about their efforts to contain costs.

Using data supplied by Thomson Reuters Bank Insight, TheStreet has identified the five actively traded U.S. banks with the lowest (best) efficiency ratios over the past year. The efficiency ratio is, essentially, the number of pennies of overhead expense a bank incurs for each dollar of revenue.

During the years of recovery from the U.S. credit and real estate crisis, banks have faced plenty of revenue pressure from narrowing net interest margins and low demand for many types of loans, while expenses tied to working out problem loans and disposing repossessed assets were elevated. At this point in the cycle, banks still have "credit leverage," as their earnings are boosted by the release of loan loss reserves and expenses are coming down as loan servicing staff levels are cut.

But many banks will report major declines in mortgage banking revenue for the third quarter, as the mortgage refinancing boom is ending; the Mortgage Bankers Association forecasts an even sharper drop in lending volume next year.

According to the MBA's latest forecast last week, refinance volume for one-to-four family mortgage loans will drop from $1.247 trillion in 2012 to $989 billion in 2013 and $388 billion in 2014. Overall volume for mortgage loan refinancing is forecast to decline from $1.750 trillion in 2012 to $1.605 trillion this year, with a much sharper decline to $1.091 trillion in 2014.

Atlantic Equities analyst Richard Staite in a report on Sept. 23 estimated third-quarter mortgage production revenue for the eight large-cap U.S. banks he covers -- including Wells Fargo ( WFC), JPMorgan Chase ( JPM), Bank of America ( BAC), Citigroup ( C), Goldman Sachs ( GS), Morgan Stanley ( MS), PNC Financial Services Group ( PNC) and U.S. Bancorp ( USB) -- will plunge 55% from a year earlier. He expects mortgage origination revenue for the group to drop 45% from the second quarter.

Adding fuel to the fire, Staite also forecasted a 20% drop in fixed-income trading revenue for the large-cap group, because "July and August were very slow months as investors sat on the sidelines waiting for more clarity on Fed tapering, Syria and the EM slowdown and we believe the weakness has extended into September."

Wells Fargo -- the nation's leading mortgage lender -- announced 4,800 layoffs of mortgage production staff during the third quarter, citing the decline in refinance volume. While the layoffs are terrible for the affected employees, they are just what investors want to hear.

As the strongest and most consistent earnings performer over the past five years among the large-cap banks listed above, Wells Fargo has long emphasized efficiency. The company's head of mortgage lending, Franklyn Codel, at a conference in May emphasized the natural offset to a decline in revenue, since his unit's sales staff is 100% commission-based and he frequently reviews staff levels as volume changes.

Wells Fargo's second-quarter efficiency ratio was 57.73% in the second quarter, improving from 58.76% the previous quarter and 58.73% a year earlier, according to Thomson Reuters Bank Insight. During the company's second-quarter earnings conference call, Wells Fargo CFO Timothy Sloan said "We expect our efficiency ratio to remain within our target range of 55% to 59%."

Bank of America laid off 2,100 employees during the second quarter, according to various media reports, and the company under the leadership of CEO Brian Moynihan continues its long-term "Project New BAC" cost-cutting program, which is meant to trim annual expenses by $8 billion from 2010 levels. The company expects the annual savings rate to reach $6 billion by the end of this year.

But with overall earnings still weak, Bank of America's efficiency ratio isn't a very impressive indicator. The second-quarter efficiency ratio was 69.80%, improving from 74.77% in the first quarter and 74.56% in the second quarter of 2012. Bank of America will announce its third-quarter results on Oct. 16, with analysts polled by Thomson Reuters estimating the bank will report earnings of 19 cents a share. In comparison, the company earned 32 cents during the previous quarter and posted a small net profit, for EPS of zero cents, in the third quarter of 2012.

Raymond James analyst Anthony Polini on Monday reiterated his "strong buy" rating for Bank of America, with a price target of $16.50, "given our positive fundamental outlook and the stock's attractive valuation." The analyst estimates Bank of America's earnings will rise considerably from 98 cents a share this year to $1.34 a share in 2014.

Using the data supplied by Thomson Reuters Bank Insight, we have identified the five actively U.S. traded banks -- with average daily trading volume of at least 40,000 shares -- with the lowest efficiency ratios. All five names are solid earnings performers that have seen strong year-to-date returns, with four beating the return of the KBW Bank Index ( I:BKX), which was up 22% year-to-date through Friday's market close.

Here they are, by descending (improving) efficiency ratio:

5. Prosperity Bancshares

Prosperity Bancshares ( PB) of Houston has seen its stock return 46% this year through Friday's close at $60.73.

The shares trade for 3.8 times their reported June 30 tangible book value of $16.05, and for 15.2 times the consensus 2014 earnings estimate of $4.00 a share, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is $3.58. Based on a quarterly payout of 21.5 cents, the shares have a dividend yield of 1.42%.

The company's efficiency ratio during the 12-month period ended Sept. 30 was 42.13%, according to Thomson Reuters Bank Insight.

Prosperity had $16.3 billion in total assets as of June 30. On Aug. 29 the company announced an agreement to acquire F&M Bancorporation of Tulsa, Okla., for roughly $244 million in stock and cash. F&M had $2.4 billion in assets as of June 30, with 10 F&M Bank branches in the Tulsa area and three in Dallas. The deal is expected to close during the first quarter of 2014.

Prosperity also has a deal in place to acquire FVNB Corp. of Victoria, Texas, for about $287.5 million in stock and cash. FVNB had $2.4 billion in assets, with 34 First Victory National Bank offices, including 12 branches in the Houston area, and one loan production office.

Following the announcement of the F&M deal, KBW analyst Jefferson Harralson reiterated his "outperform" rating for Prosperity Bancshares, with a price target of $65, saying in a note to clients that "By our estimates, the deal is 2.8% accretive to 2014 EPS assuming the deal closes at the end of the first quarter and 1.25% accretive to tangible book value ."

For the 12-month period ended June 30, Prosperity's operating return on average assets (ROA) was 1.27%, while its return on average tangible common equity (ROTCE) was 23.43%, according to Thomson Reuters Bank Insight. That's the highest ROTCE among the five efficient bank holding companies listed here, reflecting a relatively low tangible common equity ratio of 6.50% as of June 30.

PB Chart PB data by YCharts

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4. BOFI Holding, Inc.

Shares of BOFI Holding ( BOFI) of San Diego closed at $64.72 Friday, returning 133% this year.

The shares trade for 3.4 times their reported June 30 tangible book value of $19.16, and for 15.3 times the consensus fiscal 2015 EPS estimate of $3.68. The consensus 2014 EPS estimate is $3.68. The company's fiscal 2013 ended on June 30.

The company's efficiency ratio for the 12-months ended June 30 was 40.73%, while its ROA was 1.46% and its ROTCE was 16.87%.

BOFI Holding had $3.1 billion in total assets as of June 30. Its main subsidiary BOFI Federal Bank gathers deposits through its Bank of Internet USA Web site. The company on Sept. 9 announced it had completed the purchase of $173 million in deposits from Principal Bank.

After the company reported a 35% year-over-year increase in fiscal fourth-quarter earnings available to common shareholders of $11.1 million, or 78 cents a share, KBW analyst Juliana Balicka on Aug. 15 reiterated her "market perform" rating for BOFI Holding, while increasing her price target for the shares to $64 from $48. Balicka raised her fiscal 2014 EPS estimate to $3.60 from $3.05 and introduced a fiscal 2015 EPS estimate of $3.90.

In a note to clients Balicka wrote that "In 2014, we think that expense growth will moderate and that revenue will continue to ramp from the new initiatives. For example: commercial and industrial healthcare finance -- very strong pipeline growth plus associated fee income; structured settlement sales to the secondary market -- a new exit for an older loan product and source of recurring fee income."

"The bank is targeting a 40% efficiency in the intermediate term and 35% in the long-term as new business growth settles out," she added.

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3. Discover Financial Services

Shares of Discover Financial Services ( DFS) closed at $51.29 Friday, returning 34% this year.

The shares trade for 2.7 times their reported tangible book value of $19.38, and for 10.3 times the consensus 2014 EPS estimate of $4.99. The consensus 2013 EPS estimate is $4.89. That forward price-to-earnings ratio is, by far, the lowest among the five banks listed here.

Based on a quarterly payout of 20 cents, the shares have a dividend yield of 1.56%.

Discover's efficiency ratio for the 12 month period ended June 30 was 40.29%, while the company's ROA was 3.46% and its ROTCE was 26.4%, making it one of the nation's most profitable bank holding companies. The company's continued success reflects its narrow focus on credit card lending, payment services, as well as a low-cost structure for gathering deposits.

Discover has also been expanding its student lending business.

The company has continued to show solid credit card loan growth, even as U.S. consumer debt in aggregate continues to fall. Discover reported average credit card loans in August of $50.1 billion, increasing from $49.6 billion in July. That's an annualized growth rate of 12%.

During a conference presentation on Sept. 10, Discover CFO Mark Graf said there was no change in the company's outlook to be at the high end of a target annualized total loan growth rate of 2% to 5%.

Like all credit card lenders, Discover has seen credit quality improve dramatically over the past several years. The company's credit card delinquency rate was 1.6% at the end of August, and its annualized net charge-off rate for credit card loans during August was 2.0%. That's quite a low net charge-off rate when considering how profitable credit card lending is.

When asked at the conference whether credit quality could improve even more, Graf said "Yes, it could. Exactly how much, it's hard to call." He went on to say "We may have hit the plateau and we're at that point where it's hard to figure out, but we don't see anything that causes an upward turn on that in the credit profile at this point in time in the next 12 months."

By "upward turn," Graf means a sufficient decline in credit quality to cause the company to greatly increase its quarterly provision for loan losses. The provision is the amount added to reserves each quarter, which directly lowers operating revenue. Discover's second-quarter provision for loan losses was $240 million, declining from $262 million a year earlier.

In a note to clients Sept. 11, Citigroup analyst Donald Fandetti reiterated his neutral rating on Discover, with a price target of $53, writing that Graf's "positive commentary around credit should be well received by investors, as sentiment can quickly turn once card issuers begin building reserves."

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2. Signature Bank

Shares of Signature Bank ( SBNY) of New York closed at $90.50 Friday, returning 27% this year.

The shares trade for 2.5 times their reported June 30 book value of $36.10, and for 17.7 times the consensus 2014 EPS estimate of $5.10. The consensus 2013 EPS estimate is $4.55.

The bank's efficiency ratio for the 12-months ended June 30 was 37.28%. Its ROA for the same period was 1.10% and its ROTCE was 12.32%.

Signature Bank had $19.7 billion in total assets as of June 30. The bank is very much a growth story, with net loans and leases growing by 13% year-over-year, through the second quarter. The company in August announced the hiring of " seven seasoned sales professionals" to help grow its equipment leasing subsidiary, Signature Financial LLC, which was formed in March 2012.

KBW analyst Christopher McGratty in August underlined the importance of Signature Bank's leasing business. "Only 16 months old, Signature Financial has now added 19 sales executives in 17 locations throughout the country, and has already booked over $1.3B in new originations since creation," the analyst wrote in a note to clients on Aug. 20.

McGratty rates Signature Bank a "market perform," with a price target of $93.00. In his August note, he added "Signature remains on pace to exceed previous loan growth guidance of $2.2B, in our view." KBW estimates the bank will grow its loans by $2.6 billion this year.

The analyst is in the minority with his rating for Signature bank. Out of 21 sell-side analysts polled by Thomson Reuters, 15 rate Signature Bank a "buy," while the remaining six have neutral ratings.

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1. Oritani Financial

Shares of Oritani Financial ( ORIT) closed at $16.28 Friday, returning 10% this year.

The shares trade for 1.4 times tangible book value, according to Thomson Reuters Bank Insight, and for 17.1 times the consensus fiscal 2015 EPS estimate of 95 cents. The consensus fiscal 2014 EPS estimate is 86 cents. Oritani's Fiscal 2013 ended on June 30.

Based on a quarterly payout of 17.5 cents, the shares have an attractive dividend yield of 4.30%.

Oritani Financial has been the most efficient of actively traded U.S. banks, with an efficiency ratio of 36.68% for the 12-month period ended June 30. The company's ROA for the same period was 1.43% and its ROTCE was 7.71%. That last figure may seem low, but it reflects a very strong tangible common equity ratio of 18.32% as of June 30, according to Thomson Reuters Bank Insight.

The company reported net income for the quarter ended June 30 of $11.7 million, or 27 cents a share, increasing from $9.9 million, or 23 cents a share the previous quarter, and $8.3 million, or 19 cents a share, a year earlier. Earnings were boosted, in part, by a decline in the provision for loan losses to $250,000 in the most recent quarter from $1.5 million a year earlier.

Another major factor in the earnings improvement was income from bank-owned life insurance, which increased to $1.9 million in the quarter ended June 30 from $460,000 the previous quarter and $399,000 a year earlier.

FIG Partners analyst Christopher Marinac on Aug. 9 initiated his firm's coverage of Oritani with a "market perform" rating and a price target of $17.50, and discussed the company's "different (but successful) operating model" in a note to clients.

"The company utilizes a different business model than most community banks with a high Loans-to-Deposits ratio and larger-than-average use of Borrowings to fund its balance sheet," Marinac wrote, adding that the high level of borrowings is offset with the high tangible common equity ratio, "which is worth over $5.80 per share (i.e., amount above a 9% TCE ratio)."

Oritani's management "has numerous options with this excess capital to benefit shareholders," according to Marinac, who also wrote that "A special dividend or an accretive acquisition could be considered in the future."

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Interested in more on Oritani Financial? 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.