Regional Banks to Buy Into Now
Morgan Keegan likes BB&T, Synovus, SunTrust and five others.
WE BELIEVE THAT CURRENT BANK-STOCK valuations are discounting the uncertainty created by the European debt crisis, the financial-reform bill (FinReg) and the Gulf oil slick.
While headline risk is likely to remain elevated near term, increasing volatility, we believe that current valuations offer an attractive entry point to investors based on our view that despite the near-term headwinds, the U.S. economy is likely to continue on its path of slow and steady recovery and clarity on the above issues should serve as a positive catalyst for bank stocks.
With regards to the FinReg bill we believe that the most onerous provisions are likely to get watered down by the time the final bill is passed. While the impact on the economy (particularly the Southeast economy) from the Gulf oil slick is hard to handicap at this point, beyond the direct impact to the tourism and fishing industry, we could also see some near-term headwinds for the energy industry due to the administration's six-month moratorium on deepwater-oil drilling.
We favor value versus growth and believe that banks that are currently trading closer to 1.0 times year-end 2010 tangible book values (TBVs) and where capital and credit issues have been addressed, provide the most attractive risk/reward. The MK Bank Coverage Universe is currently trading at a median of 8.8 times our normalized EPS estimate and 1.3 times year-end 2010 TBV per share. Based on our view that longer term the group should trade closer to 10 to 12 times earnings and 1.5 to 2.0 times TBV we see considerable upside in banks where we believe credit issues have peaked and the banks are on their way to returning to sustainable profitability.
We would be buyers of Marshall & Ilsley (ticker: MI), Zions Bancorp (ZION), SunTrust Banks (STI), Texas Capital Bancshares (TCBI), Huntington Bancshares (HBAN), Fifth Third Bancorp (FITB), BB&T (BBT) and Synovus Financial (SNV), given the relatively attractive valuations and based on our view that these banks should lead peers in terms of continued credit improvement and a rebound in earnings.
While Synovus at 1.1 times TBV and SunTrust at 1.2 times TBV appear attractive longer term, we remain somewhat cautious due to their Florida exposure, given the uncertain impact from the Gulf oil slick that could dampen the overall Florida economic recovery.
Fundamental improvement driven by lower credit losses and expanding net interest margins coupled with strong capital and reserve ratios have positioned the banks in a relatively healthy position to deal with near-term headwinds. As an example, the Tier 1 Common capital ratio for the group stood at 9.10% at March 31, 2010, versus 7.06% at Dec. 31, 2007. This capital build has occurred during a time in which the group charged off over $250 billion during the last nine quarters.
With short-term interest rates unlikely to move near term, bank net-interest margins should continue to expand or remain relatively stable in the coming quarters. While loan demand has been sluggish so far, we expect demand to pick-up (albeit at a slow pace) in the second-half of 2010 driven by equipment financing need followed by accounts receivable, inventory build, etc.
Based on our recent conversations with bank management teams in the
Gulf region and other industry participants, we believe it is too early to fully handicap the impact from the oil slick. While the tourism (including retail and restaurants catering to tourists) and fishing industries are likely to be directly hit, on the other hand there are likely to be companies that should benefit from the clean-up efforts.
In addition, the extent to which BP (BP) will reimburse the losses incurred by the region remains unknown. Another adverse impact is likely to come from the six month moratorium imposed by the Obama administration on deepwater-oil drilling.
We believe the passage (likely by July 4) of the FinReg legislation could serve as a positive catalyst for bank stocks as it would provide the much-needed clarity on several key issues for bank-stock investors. Final capital levels may still remain unknown until the international rules are set (likely by year end) under the Basel III rules. However, we believe that key provisions such as Lincoln (derivatives/swaps), Collins (trust-preferred securities), Durbin (interchange legislation) and a few others are likely to get watered down by the time the final legislation is passed.
With the Federal Deposit Insurance Corp. steadily scaling back assistance on failed bank transactions and given the significant competition from buyers during recent failed bank bids, we are seeing increasing signs for a return to regular mergers-and-acquisitions activity over the next 12 months. The recent (announced May 17) acquisition of South Financial Group (TSFG) by Toronto-Dominion Bank (TD) was done without any credit guarantees (although the Treasury did take a haircut on its Troubled Asset Relief Program [TARP] investment).