Negative earnings-per-share revision risk is currently lower for the commercial and variable-rate focused U.S. regional banks than for other financials.
Specifically, we believe the underlying earnings power is higher than the market is embedding with the stocks trading at six times our 2014 EPS with no assumed rate hike.
For example, when we isolate the impact of the flatter-yield curve on each bank's fixed-rate loan and securities portfolio, and on certificate-of-deposit balances, the least-asset-sensitive banks will see material core net-interest margin pressure including Bank of Hawaii (ticker: BOH), BB&T (BBT), M&T Bank (MTB) and TCF Financial (TCB). But the most asset-sensitive banks: Comerica (CMA); First Horizon National (FHN); and Zions Bancorp (ZION) should see very little pressure.
Recall that the U.S. regional banks are overweight on commercial credit (not consumer credit), with yields mostly based on short-term rates (already low for three years) versus long-term rates (which have declined sharply recently).
Our top longs are currently Fifth Third Bancorp (FITB), Synovus Financial (SNV) and Zions Bancorp, and we are more positive on Comerica.
Capital and liquidity levels are very high and conservative, and the embedded-credit risk in bank balance sheets is low -- this is not 2007. We expect the stocks to trade up to eight-10 times our 2014 estimate by mid-2013, which implies 45% upside before dividends (the current yield is 2.5%) and 1.3 times multiple on 2014 tangible book value.
We assume a 1.50%-2.50% range on the U.S. 10-year Treasury and no Federal Reserve rate hikes until 2015.
We expect third-quarter results to be solid, while fourth-quarter guidance for net-interest margin should be a little softer. In the third quarter, we expect positive-loan growth, credit-quality improvement, 3%-4% tangible-book-value growth (with accumulated other comprehensive income (AOCI)), and a lack of downside to net-interest margins to cause aggregate results to exceed expectations.
However, at the September conferences and on the third-quarter earnings calls, management language regarding net-interest margins and the impact from the flatter-yield curve will be more conservative, but we believe this is already embedded in current valuations.
Alternatively, we expect banks to become more aggressive in reducing expenses, repurchasing stock, and mergers-and-acquisitions-driving general-industry consolidation slowly over the next year. Also, debt and CD refinancing and maturities will provide another stealth lever to offset declining asset yields.
We are upgrading Synovus to Outperform from Neutral and BB&T to Neutral from Underperform, and also recommend Fifth Third and Zions Bancorp as our top long ideas.
Our investment process relies heavily on the analysis of the bank regulatory filings to build a standardized analysis across the industry.
Given the elevated level of interest-rate risk, we also leveraged the Credit Suisse Macro/Fixed Income strategy teams to build a solid understand of the macro risks.