NEW YORK (TheStreet) -- Following a fantastic recovery for U.S. bank stocks over the past two years, investors may wish to focus on quality, rather than credit recovery and valuation recovery, in 2014.
"In Washington, 2014 will be the year of the regulator," Miller wrote.
You may be scratching your head at this statement, since 2013 surely has been an amazing year for regulators in their efforts to punish banks for their mortgage sins during the real estate bubble, and has also seen the finalization of Basel III capital rules, the finalization of regulations to implement the Volcker Rule's ban on proprietary trading for banks, new liquidity rules and the announcement of an expanded list of banks subject to annual Federal Reserve stress tests.
But the Senate's recent approval of Majority Leader Harry Reid's (D., Nev.) proposal to lower the number of votes required to break filibusters blocking confirmation votes for presidential appointees to 50 from 60 will allow "for greater control over confirming regulators and judges [and] is likely the beginning of a more aggressive regulatory stance," Miller's report contends.
"It is clear that many in Washington want to expand mortgage credit availability, and the debate will focus on their success. The Consumer
Financial Protection Bureau (CFPB) remains a significant source of focus and has recently added overdraft fees and payday loans to its 2014 regulatory agenda," it goes on.
So the major transformation of the banking business is going to continue.
On a brighter note, Miller says investors "should pay attention" to the efforts of incoming Federal Housing Finance Agency director Mel Watt's efforts to expand consumers' access to mortgage credit, through changes of underwriting requirements at Fannie Mae F (NMA) and Freddie Mac (FMCC). The analyst also expects "actions by the CFPB to loosen credit. Those actions could provide a boost for the two mortgage-focused names among Miller's top five picks, which are Flagstar Bancorp (FBC), and New Residential Investment Corp. (NRZ).
Miller's remaining top pick for 2014 is American Homes 4 Rent (AMH).
For the big banks, Miller expects continued slow balance sheet growth, but he does expect banks' net interest margins "to begin to climb at a modest pace."
Credit leverage has been a major theme for the largest banks for several years, as they release excess loan reserves, which is typical during an economic recovery. But the big reserve releases are coming to an end, which brings us back to a focus on quality.
U.S. Bancorp and Capital One have both put up impressive numbers this year. USB's return on average tangible common equity for the first three quarters was 24.18%, according to Thomson Reuters Bank Insight, while Capital One's ROTCE was 17.02%. Please see TheStreet's earnings coverage for details on third-quarter results for U.S. Bancorp and Capital One.
U.S. Bancorp's shares closed at $40.04 Thursday. The shares have returned 28% this year and trade for 12.5 times the consensus 2014 earnings estimate of $3.20 a share, among analysts polled by Thomson Reuters, and for 11.6 times the consensus 2015 EPS estimate of $3.46.
Miller on Friday raised his price target for USB to $50 from $42, "reflecting 14x FY15 consensus of $3.50 and 15x our FY14 EPS estimate of $3.25." Miller expects a continued strong return on equity to "bode well" for an expanded forward price-to-earnings ratio, during a year that will be "otherwise lackluster for banks, as the demand for credit remains relatively weak and employment gains continue to be minimal."
Capital One's shares closed at $73.64 Thursday, returning 29% this year. The shares trade for 10.6 times the consensus 2014 EPS estimate of $6.94 and for 9.9 times the consensus 2015 EPS estimate of $7.43.
Miller raised his price target for Capital One to $85 from $82, "reflecting 12.0x our FY14 EPS estimate of $7.05 and the consensus FY14 EPS estimate of $7.06. Following a decline in Capital One's credit card portfolio this year, Miller expects a resumption of growth during 2014, as the planned runoff of card balances acquired from HSBC (HSBC) ends. Miller also expects expense cuts and an increased return of capital to investors through dividend increases and/or share buybacks to " drive a higher valuation."
USB's stock was up slightly in late morning trading Friday to $40.10, while Capital One was up 0.8% to $74.22.
The following chart shows the performance this year of U.S. Bancorp and Capital One against the KBW Bank Index (I:BKX) and the S&P 500
data by YCharts
-- Written by Philip van Doorn in Jupiter, Fla.
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