NEW YORK (TheStreet) -- Fourth-quarter bank earnings season has similar negative factors to the third quarter, namely a continued decline in mortgage loan production as long-term rates have risen, continued pressure on net interest margins as short-term rates remain near zero, and the golden sunshine of strong growth in commercial and industrial loans for a good number of regional players.
But looking ahead, continued economic growth should drive an increase in C&I and commercial real estate lending during 2014, as small businesses expand, according to Goldman Sachs analyst Ryan Nash. Goldman's equity analysts also expect pressure on net interest margins finally to subside during 2014.
Investors have pushed long-term interest rates considerably higher, with the market yield on 10-year U.S. Treasury bonds now at 2.88%, compared to 1.70% at the end of April last year. This increase was in anticipation of the "tapering" of the Federal Reserve's monthly "QE3" purchases of long-term bond, announced by the Federal Open Market Committee last month.
But for 2014, the big interest rate story is the Fed's eventual change of policy for its main tool: the short-term federal funds rate, which has remained in a range of zero to 0.25% since late 2008. The FOMC has repeatedly said that baring a rise in inflation, it was unlikely to raise the federal funds rate until the U.S. unemployment rate fell below 6.5%.
We're getting close to that level, with the Department of Labor saying Friday that the unemployment rate declined to 6.7% in December from 7.0% in November and 7.3% in October. That's a very rapid improvement in the unemployment rate, however, a deeper look into the Labor Department's numbers shows that the news isn't all good. U.S. nonfarm payrolls grew by only 74,000 during December, missing the consensus estimate of 192,000 among economists polled by Thomson Reuters, by a very wide margin.
The decline in the unemployment rate during December was driven in part by a 0.2% decline in the labor participation rate to 62.8%. The labor participation rate declined 0.8% during 2013 -- a large number of people have effectively been driven from the labor force.
Therefore, the Fed may take its time in raising the federal funds rate, even after the unemployment rate drops below 6.5%.
But the eventual rise in the federal funds rate bodes very well for most banks, whose balance sheets are structured in such a way that a parallel rise in interest rates will significantly grow their margins and their net interest income.
Goldman Sachs on Thursday added SunTrust (STI) of Atlanta to its "Conviction Buy List," and Nash also listed three other "top picks" among regional banks. These four stocks all trade at significantly higher forward price-to-earnings multiples than the largest U.S. banks, however, "leverage to an improving economy should allow for multiples to expand further and higher interest rates should help earnings over time, driving [returns on assets] closer to historical averages," Nash wrote in a note to clients.
Shares of SunTrust closed at $38.01 Thursday. The shares trade for 1.5 times tangible book value, according to Thomson Reuters Bank Insight, and for 11.6 times the consensus 2015 earnings estimate of $3.27 a share. The consensus 2014 EPS estimate is $2.96.
Nash on Thursday raised his price target for SunTrust's shares to $45 from $41. He's ahead of the consensus, estimating the bank will earn $3.05 a share this year, with EPS growing to $3.40 during 2015.
The major catalyst for SunTrust's expected earnings improvement is a decline in expenses from nonperforming loans, as well as the company's cost-cutting initiatives. The company reported an efficiency ratio -- essentially the number of pennies of overhead expenses incurred for each dollar of revenue -- of 73.41% for the first three quarters of 2013. Nash expects SunTrust's efficiency ratio to improve to 63% during 2014 as revenue improves and because "its mortgage banking restructuring should be completed by 2Q14, reducing headcount by about 800 and expenses by $50mn/qtr," according to Nash. SunTrust's review of back-office expenses "should result in at least another $60mn-$100mn in [annual] cost savings," Nash added.
SunTrust also has more "credit leverage" than most large regional banks, with the companies annualized charge-off rate for residential loans "currently" at 0.84%, according to Nash, who expects that figure to decline to 0.10% to 0.12%.
Nash also expects SunTrust's loan growth during 2014 "to outperform peers," because of the stronger employment growth in the company's market area, and because of an increase in commercial borrowers' capital expenditures.
SunTrust will announce its fourth-quarter results on Jan. 17, with analysts polled by Thomson Reuters estimating EPS of 69 cents, increasing from 33 cents during the third quarter, when the company announced several mortgage settlements with regulators and investors, and 65 cents during the fourth quarter of 2012.
BB&T Corp. (BBT) of Winston-Salem, N.C., closed at $38.40 Thursday. The shares trade for 2.2 times tangible book value and 11.5 times the consensus 2015 EPS estimate of $3.34. The consensus 2014 EPS estimate is $3.03.
Nash raised his price target for BB&T to $44 from $39. He estimate the company's EPS will grow from $3.10 during 2014 to $3.45 during 2015.
BB&T is "On its way to reclaiming the best bank in town title," Nash said, in part because its balance sheet is leverage to the long-tend of the interest rate curve, that is, the part of the curve already going up, as the Federal Reserve curtails its bond-buying.
Nash also credits the company with having a net charge-off rate on loans than peers, and expects BB&T's loan growth to "outpace peers as commercial real estate growth accelerates and several of its growth initiatives (corporate C&I, TX, specialized lending)," lead to an expected loan growth rate of 5% this year.
BB&T will announce its fourth-quarter results on Jan. 16, with analysts expecting EPS of 72 cents, increasing from 70 cents the previous quarter and 71 cents a year earlier.
Shares of First Republic Bank (FRC) of San Francisco closed at $51.50 Thursday. The shares trade for 2.3 times tangible book value and 15.1 times the consensus 2015 EPS estimate of $3.41. The consensus 2014 EPS estimate is $3.10.
Nash raised his price target for First Republic to $62 from $58, and he is a bit ahead of the consensus, estimating FRC will earn $3.15 a share this year, with earnings increasing to $3.45 a share during 2015.
First Republic is often listed by analysts as one of the best growth plays in the industry. The bank had $41 billion in total assets as of Sept. 30, increasing 10% for the third quarter alone. Total loans grew 6.3% during the third quarter and 21.6% year-over-year to $32.3 billion as of Sept. 30.
The bank focuses on jumbo mortgage lending, tied into its wealth management business, but has also seen very solid growth in multifamily mortgage loans and commercial loans.
First Republic reported a return on average assets (ROA) for the first three quarters of 2013 was 1.26%, down slightly from 1.28% a year earlier, while its return on average common equity (ROCE) improved to 13.91% during the first three quarters from 12.38% in the prior-year period. These were impressive results, considering the bank's net interest margin contracted to 3.71% during the first three quarters from 4.26% a year earlier.
Nash expects First Republic's very strong growth to continue, as "growth among its core client base outpaces US GDP growth (clients expected to grow net-worth 8-9%)." He also expects the bank's net interest margin to bottom soon, and for a continued build-out of the wealth management business.
The bank will announce its fourth-quarter results on Jan. 16, with analysts expecting EPS of 75 cents, matching the previous quarter, but down from 77 cents a year earlier.
Regions Financial (RF) of Birmingham, Ala., closed at $10.45 Thursday. The shares trade for 1.5 times tangible book value and for 11.5 times the consensus 2015 EPS estimate of 91 cents. The consensus 2014 EPS estimate is 84 cents.
Nash raised his price target for Regions by a dollar to $12.00. He's a penny ahead of the consensus, estimating Regions will earn 85 cents a share this year and 92 cents a share in 2015.
"Key themes" for Regions during 2014 include a modest expansion of the net interest margin, controlled expenses, "as growth initiatives (wealth management, industry verticals) are offset by further branch rationalization (> 35% of branches are within 1 mile of each other and > 65% of branches have <$50mn deposits, both above peers)," according to Nash.
Regions reported an adjusted efficiency ratio of 67.3% for the third quarter, which was on the high end for the past five quarters, when the adjusted efficiency ratio was as low as 62.7%. Nash expects the efficiency ratio to be below 65% during 2014.
He also expects "an inflection in its run-off portfolios as they move from a drag to growth, driving loan growth above its 2-4% guidance."
The bank will announce its fourth-quarter results on Jan. 21, with analysts expecting EPS of 20 cents, matching the third-quarter and down a penny from the fourth quarter of 2012.
The following chart shows the stock performance of Goldman's four "top picks" among regional banks, 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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