Trading Bank Earnings, Part 2

NEW YORK (TheStreet) -- A couple of weeks ago I reviewed four of the largest money center banks in Trading Bank Earnings, Part 1, which broke down the earnings results and identified the best investment opportunities among those.

Now, I will focus on the 12 regional banks, with assets ranging from $50 billion to almost $400 billion. The last two articles in the series will focus the nine financial service firms (credit card companies, asset management firms) and eight global banks with an extensive U.S. presence.

Below I will give you some of my picks and pans in the group.

So, how did the "super-regional" banks fare, and how can you profit going forward? Among the groups I follow, the regionals had a 75% rate of meeting or beating analysts' estimates and stock price appreciation of just 0.5% over three weeks.

This is the second lowest of all other groups including the four money center banks, at 0.4%, eight global banks, at 0.9%, and the nine financial service companies, at 1.6%. The table below indicates key metrics and highlights which banks met or beat earnings and those that missed and by how much.

Of the 12 "super regionals," five exceeded first-quarter 2014 expectations: PNC Financial Services Group (PNC) beat by 9.6%; KeyCorp (KEY) beat by 8.3%; Bank of New York Mellon Corp. (BK) beat by 7.5%; SunTrust Banks (STI) beat by 10.6% and Regions Financial (RF) beat by 10%.

Four banks just met estimates: U.S. Bancorp (USB); M&T Bank (MTB); Comerica (CMA) and Huntington Bancshares (HBAN).

The three that missed were BB&T Corp. (BBT), which missed by 1.4%; Fifth Third Bancorp (FITB), by 12.2% and Zions Bancorp. (ZION) missed by 2.4%.

Most of the earnings misses were due to a revenue shortfall from the prior quarter for BBT and FITB with declines of 4.2% and 6.3%, respectively for both banks. Zions was hampered by other operating issues including failing both parts of the Federal Reserve's stress test.

The clear winners of the group were PNC and Bank of New York Mellon -- both banks beat estimates and have the highest share price appreciation over the last 22 days, just prior and after earnings, of 3.1% and 3.3%, respectively. The only other strong price appreciation performer came from M&T Bank, which, although only met earnings expectations, saw the stock price ascend by 2.8%.

This was primarily due to the fact that investors were relieved M&T has only met or beat earnings in seven quarters of the last three years prior to 1Q 2014, one of the lowest numbers other than Zions Bank, which only met or beat in six quarters.

Other strong performers that also beat but did not enjoy a huge pop in their stock price as of early May were KeyBank -- while beating estimates in all 12 quarters only had a stock price appreciation of 1.3% -- and SunTrust, beating in 10 of 12 quarters since 2011 with just 0.5% appreciation in stock price over the 22 days just prior and after earnings.

The regional banks that met or beat primarily did so by cost cutting and release of loan loss reserves as only 2 of 12 banks had revenues that were higher in 1Q 2014 from the prior quarter: Zions Bancorp., up 38.4% and Huntington Bancshares, up 0.9%. Two had no deterioration in quarter over quarter revenues: KeyBank and M&T Bank. The banks with the biggest drop in revenue were PNC, down 7.3%; Fifth Third, down 6.3% and Regions Financial, down 7.1%.

Of the four regional banks in my previous article, both PNC and U.S. Bancorp lived up to expectations by meeting or exceeding estimates while BB&T and Fifth Third disappointed investors with earnings misses. As a result, their short-term stock prices were punished with declines of 3.9% and 5.7%, respectively.

If you missed the short-term appreciation on banks like PNC and Bank of New York Mellon then how can you profit if you are a long-term investor with a buy-and-hold strategy? The table below shows the revised fiscal year earnings estimates for 2014 and 2015 along with price targets and potential returns.

Over the next year, the best plays based on current valuations and stock price appreciation for FY2014 would be PNC, Regions Financial, Fifth Third Bancorp and SunTrust, all with expected returns greater than 20% based on a historical industry price-to-earnings ratio of 15.

Current stock prices would give these stocks some of the lowest forward-looking P/E ratios, at between 11 to 12 times. However, given that Fifth Third missed badly by 12.2% in the first quarter of 20414, further downward revisions for the remainder of fiscal 2014 may limit potential returns going forward.

As a result, I would be a buyer of lean PNC, Regions Financial and SunTrust as they provide more reliable upside potential and are less vulnerable to downward earning estimate revisions.

The next most reliable group for a longer-term investment would be KeyBank and Huntington Bancshares as both of these bank stocks had the least variance between best upside surprise beats and worst misses (none for KeyBank) and still provided a healthy forecasted return of 14% and 15%, respectively.

While M&T Bank and Bank of New York Mellon are poised to have stellar longer-term expected returns for fiscal year 2015 of 15.9% and 13.5%, respectively, investors should avoid Zions Bancorp and Comerica as returns for these banks are projected to be negative or in the single digits over the next two years.

As a group, the "super regional" banks outperformed the money center banks in short-term stock appreciation since the first quarter 2014 earnings season were announced, with the regionals showing a 1% aggregate return versus a decline of 0.3% for the money center banks as of May 12.

They also outperformed the big banks in average return earnings estimate beat with an average beat of 3.1% for the regionals versus an average miss of 2% for the money center banks. As an added bonus, the regional group also provides a better average dividend return than the big banks: 2.1% versus 1.5%.

Where the big money center banks have the advantage is that the group is expected to outperform the "super regionals" in longer expected returns based on fiscal year earning estimates for 2014 and 2015. The big bank group average stock price return for FY 2014 is expected to be 38% while the regionals are only forecasted to appreciate 8.7%.

The gap closes somewhat in FY 2015 with the mega banks forecasted to return 13.7% and the regionals up 9.5% based on an historical price to earnings ratio of 15 times. Of course these forecasts are predicated on the banks being able to meet earning estimates going forward and some of the banks in both lists are vulnerable to downward revisions after having missed the current quarter estimates.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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