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.