NEW YORK ( TheStreet) -- After a very strong run, the banking sector is now "fairly valued," according to Oppenheimer analyst Terry McEvoy, but there are still some undervalued names for investors to focus on. "We believe the sector is fairly valued following the strong performance this year," with banks trading for roughly 12 to 15 times 2014 earnings estimates and 1.5 to 1.9 times tangible book value, McEvoy wrote in his third-quarter banking industry earnings preview on Tuesday. The KBW Bank Index ( I:BKX) has risen 19% this year, following a 30% return during 2012. McEvoy and his research team have "market perform" ratings on most of the regional bank stocks they cover, but the analyst has "four top picks" heading into third-quarter earnings season, including BB&T ( BBT), KeyCorp ( KEY), FirstMerit ( FMER) and Signature Bank ( SBNY). A major theme heading into third-quarter earnings is the decline in mortgage loan production, as rising long-term interest rates have curtailed the refinancing boom and have also led to lower gains on the sale of new loans to Fannie Mae ( FNMA) and Freddie Mac ( FMCC). McEvoy projects a 30% decline in mortgage production revenue for the industry. Atlantic Equities analyst Richard Staite in his third-quarter earnings preview for eight large-cap banks on Sept. 23 took an even more negative tone, estimating sequential decline in mortgage revenue of 45% and a year-over-year decline of 55%. Staite also expects the biggest banks to see a 20% year-over-year decline in trading revenue. "Not having large trading platforms should help
regional banks' comparisons with the money center/investment banks," McEvoy wrote. The "big four" U.S. banks trade significantly lower to forward earnings estimates than the P/E ratios for the regional banks of 12 to 15 times cited by McEvoy, reflecting not only the pressure on earnings from lower mortgage activity and declining trading revenue, but also the continued regulatory overhang, including uncertainties over the implementation of some elements of the Dodd-Frank banking reform legislation and a rising bar for capital requirements:
- Shares of JPMorgan Chase (JPM) closed at $50.87 Tuesday and traded for 8.5 times the consensus 2014 earnings estimate of $6.00 a share, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is $5.74. Analysts on average estimate JPMorgan will report third-quarter net income of $4.794 billion, or $1.21 per share. In comparison, the bank earned $1.60 a share during the second quarter and $1.40 a share during the third quarter of 2012. JPMorgan's revenue is expected to decline to $24.059 billion during the third quarter from $25.958 billion the previous quarter and $25.863 billion a year earlier.
- Wells Fargo (WFC) closed at $40.24 Tuesday and traded for 10.1 times the consensus 2014 EPS estimate of $4.00. The consensus 2013 EPS estimate is $3.84. The company is expected to announce third-quarter net income of $5.211 billion, or 97 cents share, compared to 98 cents the previous quarter and 88 cents a year earlier. The consensus third-quarter revenue estimate is $20.993 billion, declining from $21.378 billion in the second quarter and $21.213 billion in the third quarter of 2012.
- Bank of America's (BAC) shares closed Tuesday at $13.69 and traded for 10.1 times the consensus 2014 EPS estimate of $1.36. The consensus 2013 EPS estimate is 89 cents. Analysts expect the company to post third-quarter net income of $2.169 billion, or 19 cents a share, compared to a 32-cent profit during the second quarter and a break-even third quarter of 2012, when debit valuation adjustments and several one-time items wiped out earnings. The consensus third-quarter revenue estimate is $22.082 billion, compared to $22.727 billion the previous quarter and $20.428 billion a year earlier.
- Citigroup (C) closed at $47.67 Tuesday and traded for 8.6 times the consensus 2014 EPS estimate of $5.52. The consensus 2013 EPS estimate is $4.80. Citigroup's consensus third-quarter earnings estimate is $3.253 billion, or $1.06 a share, compared to $1.34 a share in the second quarter, and 15 cents a share in the third quarter of 2012, when the company booked a $2.9 billion after-tax loss on the valuation of its share of the joint brokerage venture with Morgan Stanley (MS). Citigroup's revenue for the third-quarter is projected to total $18.796 billion, down from $20.479 billion the previous quarter, but up considerably from $13.951 billion a year earlier, which included a $4.7 pretax hit from the write-down of Citi's share of the joint venture, which the company was preparing to sell to Morgan Stanley.
Another negative trend heading into earnings season is a decline in "credit leverage," which is a natural part of a bank recovery cycle. "Earnings growth for the largest 100 regional banks continues to slow as the benefits of lower credit costs lessen each quarter," McEvoy wrote. Following years of loan loss reserve builds during the credit crisis, banks have been "releasing" reserves as expected, which has provided a boost to earnings results. As more banks' reserve levels come down to the appropriate levels based on anticipated loan charge-off activity, the temporary boost to earnings comes to an end. While this natural during a credit recovery, it can add to investors' negativity this earnings season. Here's a quick summary of McEvoy's favorite bank stocks heading into earnings, all of which he rates "outperform."
BB&TShares of BB&T of Winston-Salem, N.C., closed at $32.66 Tuesday, returning 15% this year. The shares trade for 10.6 times the consensus 2014 EPS estimate of $3.08. The consensus 2013 EPS estimate is $2.92. BB&T is scheduled to announce its third-quarter results on Oct. 17, with analysts estimating net income of $493 million, or 70 cents a share, declining from 77 cents the previous quarter, but increasing from 66 cents a year earlier. McEvoy's 12-to-18-month price target for BB&T is $40. "Over the past 15 years, shares of BB&T have traded at approximately 12.5x price-to-forward earnings," he wrote, adding that "Given the company's growth prospects, diversified revenue stream, recent footprint expansion and expectations for increased capital returns in 2014, we feel BB&T's multiple will expand the average again." The analyst's price target for BB&T is based on a multiple of 12.5 times his 2014 EPS estimate of $3.20. Oppenheimer's 2014 EPS estimate for BB&T is $3.05.
KeyCorpKeyCorp of Cleveland has seen its stock return 36% this year, closing at $11.30 Tuesday. The shares trade for 11.3 times the consensus 2014 EPS estimate of $1.00. The consensus 2013 EPS estimate is 89 cents. The company will report on Oct. 16, with analysts expecting third-quarter earnings of $204 million, or 22 cents a share, matching EPS for the previous quarter, but down a penny from 23 cents a year earlier.
McEvoy's price target for KeyCorp is $13, "which equates to 13x our 2014 EPS estimate
matching the consensus EPS estimate of $1.00 and 1.3x tangible book value," he wrote. "Based on our and consensus estimates, a peer group of regional banks currently trades at 13x 2014E EPS and 1.7x tangible book value," McEvoy wrote, adding "We believe KEY should trade at a slight discount to its peers on a P/TBV basis given the higher capital levels." of $1.70 , with a peer group of regional banks (assets $12B-$50B) trading at 15x OPCO and consensus EPS estimates," he wrote.
FirstMeritShares of FirstMerit of Akron, Ohio, closed at $21.62 Tuesday, returning a whopping 56% this year. The shares trade for 13.9 times the consensus 2014 EPS estimate of $1.56. The consensus 2013 EPS estimate is $1.26. The company will announce its third-quarter results on Oct. 22, with a consensus earnings estimate of $56.5 million, or 34 cents a share, increasing from 29 cents the previous quarter, but matching the EPS a year earlier. FirstMerit is clearly a growth play. While the stock's valuation to the consensus 2014 EPS estimate is significantly higher than the forward P/E ratios for BB&T and KeyCorp, the valuation appears low when considering the company's 12% organic loan growth rate over the past year. Please see TheStreet's recent coverage of FirstMerit's growth strategy, which includes making large acquisitions "without giving away the store," according to JPMorgan analyst Steven Alexopoulos. McEvoy's price target for FirstMerit is $24, "which equates to 14x our 2014 EPS estimate
Signature BankShares of Signature Bank closed at $90.77 Tuesday, returning 27% this year. The shares trade for 18.0 times the consensus 2014 EPS estimate of $5.05. The consensus 2013 EPS estimate is $4.50. Analysts expect the bank to post third-quarter net income of $55.6 million, or $1.16 a share, increasing from $1.08 in the second quarter and 91 cents in the third quarter of 2012. Signature Bank is one of the fastest growing U.S. banks, with net loans and leases up 13% year-over-year through the second quarter. The company has been quickly expanding its national equipment leasing business.
McEvoy's price target for Signature Bank is $100, "which equates to approximately 17.6x our 2015 EPS estimate and 2.0x our estimated year end '15 tangible book value estimate." The analyst estimates the bank will earn $5.70 a share in 2015. Signature Bank's shares trade at roughly a 20% premium to peers, which the analyst feels is justified, because of "the more favorable outlook for SBNY's net interest margin and above-peer balance sheet growth through the end of 2015." -- Written by Philip van Doorn in Jupiter, Fla. >Contact by Email. Follow @PhilipvanDoorn