Discover: Bank Stock Winner

NEW YORK ( TheStreet) -- Discover Financial Services ( DFS) was the winner among major U.S. banks on Monday, with shares rising 2% to close at $52.81.

The broad indices strengthened late in the trading session, on the 14th day of the partial shutdown of the federal government. After Republican leaders in the House of Representatives late last week met with President Obama but failed to come to an agreement, Senate leaders have been working toward a compromise for the government to resume full operations and for an increase in the $16.7 trillion debt limit.

U.S. Treasury Secretary Jack Lew has repeatedly warned that the government could run out of money to pay its bills by Oct. 17, without an increase to the debt limit, although some analysts have said the government could probably go on operating until the end of October.

Politico on Monday reported that Senate Majority Leader Harry Reid (D., Nev.) had "privately" offered a deal to Senate Minority Leader Mitch McConnell (R., Ken) that would fully reopen all federal agencies at least until "mid-to-late December," while also extending the debt ceiling so that the government wouldn't hit its next debt limit until 2014. This would provide plenty of breathing room for negotiations between leaders of Congress and Obama, however, investors have learned to expect no deals until the last possible moment.

Later Monday afternoon, Reid on the Senate floor said he was "very optimistic" he would reach a deal with McConnell. A meeting at the White House between Obama and congressional leaders scheduled for 3 p.m. ET, was postponed to allow the Senate leaders to continue negotiating.

The KBW Bank Index ( I:BKX) rose 0.6% to 63.92, with all but one of the 24 index components ending with gains.

Earnings Season

After a notable start to third-quarter earnings seasons for the largest U.S. banks -- with JPMorgan Chase ( JPM) on Friday reporting a net loss of $380 million, or 17 cents a share, springing from a provision for litigation reserves that came to $7.2 billion after tax, or $1.85 a share -- none of the large U.S. banks reported on Monday.

JPMorgan also disclosed that its litigation reserves totaled $23 billion as of Sept. 30, and said that additional losses from regulatory investigations and lawsuits demanding the repurchase of securitized mortgage loans could total as much as $5.7 billion more. The company has been negotiating with the Department of Justice, federal bank regulators and states' attorneys general on a global settlement of numerous civil and criminal investigations of its mortgage lending, servicing and sales activities, with media reports saying the settlement could climb as high as $11 billion.

Despite the bad news on Friday, KBW analyst Christopher Mutascio's enthusiasm for JPMorgan is undiminished. "For those who can look through the large $9.2 billion litigation reserve build, the company's core performance was actually quite solid in a still challenging revenue growth environment," the analyst wrote in a note on Monday.

Mutascio reiterated his "outperform" rating for JPMorgan and stuck with his price target for the shares of $63, while maintaining his 2014 earnings estimate of $5.95 and his 2015 EPS estimate of $6.30.

The analyst also took solace in what JPMorgan CEO James Dimon repeatedly calls the company's "fortress balance sheet," writing "the one-time disclosure of the company's level of litigation reserves ($23 billion) should provide some comfort to investors when assessing the strength of the company's overall balance sheet. If you add the $23 billion in litigation reserves to the company's $195 billion in common capital, $17 billion in loan loss reserves and $2 billion in loan repurchase reserves, the company has nearly $240 billion in high quality capital/cushions."

JPMorgan's shares on Monday rose 0.4% to close at $52.69. The regulatory overhand has caused JPMorgan's stock to be among the cheapest of all actively traded bank stocks, trading for just 8.8 times the consensus 2014 EPS estimate of $5.98, among analysts polled by Thomson Reuters.

Next up is Citigroup ( C), which will announce its results early Tuesday. Analysts on average estimate the company's third-quarter earnings will come in at $3.223 billion, or $1.04 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 $18.828 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 writedown of Citi's share of the joint venture, which the company was preparing to sell to Morgan Stanley.

Like JPMorgan, Citi's shares trade at a low valuation relative to nearly all actively traded bank stocks. The shares rose nearly 1% Monday to close at $49.65, and traded for 9.0 times the consensus 2014 EPS estimate of $5.51.

Discover

Discover's shares have returned 38% this year and trade for 10.5 times the consensus 2014 EPS estimate of $5.04.

The card lender has stood out by reporting an annual growth rate of 12% for average credit card loans held on the balance sheet during August, and achieving an industry-leading efficiency ratio of 40.29% for the 12-month period ended June 30.

Deutsche Bank analyst David Ho on Monday initiated his firm's coverage of Discover with a "buy" rating and a price target of $62, representing upside potential of 17% from Monday's closing share price.

In a note to clients entitled "Growth is in the Cards," Ho called Discover "a compelling growth story within financials over the next consumer leveraging cycle."

"We expect above average loan growth in both a sluggish macro environment and as consumer loan demand accelerates," Ho wrote, adding that the loan growth "will translate into positive EPS revisions over time from likely better than expected net interest margin trends, benign credit costs, meaningful excess capital and high margin payment assets."

Ho estimates Discover will earn $4.90 a share this year, with EPS growing to $5.03 in 2014 and $5.55 in 2015.

DFS Chart DFS data by YCharts

Interested in more on Discover Financial Services? See TheStreet Ratings' report card for this stock.

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-- 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.