Looking for Regional Banks Stocks to Take a Breather with 3Q Results. Since
the mid-point of 2009 the mid-cap banks have now rallied 19% higher
outperforming a 12% increase in the S&P, tied to several key factors, which
included the sector being recapitalized in the latter half of 2Q, recent economic data
implying the economic freefall abated, and key bank fundamentals, such as NIM as
well as growth rate of nonperforming assets, showing a linked quarter improvement
with 2Q results. With key fundamental trends unlikely to show further material
linked quarter improvement and the stocks now trading 19% higher on average
versus the mid-point of 2009, we think it is likely that many banks stocks take a
breather and trade flat to down on 3Q results.
• Fundamentals Unlikely to Show Material Linked Quarter Improvement. This
quarter we are looking for 7 of 20 banks to report losses, consistent with 2Q, with 9
expected to beat, 4 in-line and 7 expected to miss Street estimates. In terms of key
fundamentals we look for: (1) NIM to be flat with an upward bias as the drag from
excess liquidity subsides and commercial loans reprice higher in conjunction with
many banks reducing CD reliance, (2) reserve build to be fairly consistent with the
2Q rate with an upward bias tied to placing incremental reserves on SNCs , (3) the
median NCO ratio to decline from 1.45% to 1.3% as the source of losses gradually
moves from resi construction to areas of less loss severity such as CRE and C&I, (4)
NPA growth of 17%, fairly consistent with 2Q although SNCs could be a swing
factor, (5) loan growth to be negative, (6) deposit growth to slow, and (7) median
TCE ratio to drift from 7.1% to 7.2% as many in the group recapitalized in 3Q.
• Normalized EPS Likely to Move Further to Center Stage, but Timing is
Everything. With a relatively benign 3Q expected, we see investors gravitating even
more so to normalized EPS valuations to find the next bargains. The bad news with
this strategy is that with so many investors basing buy decisions on “theoretical
earnings,” while the stocks may appear “cheap” over a 3-5 year time horizon, they
may actually be overpriced in a 6-month to 1 year time horizon with Zions being the
poster child for this paradox. To compensate for this contradiction in valuing stocks
on theoretical earnings in a normal environment, we suggest that investors focus on
the timing of when normal earnings are likely to be realized, which in our view is an
equally significant valuation factor as the level of normalized earnings itself. As key
variables such as share count, business models, and operating losses change as the
industry works through the remainder of the economic downturn, and more certainty
is placed on the timing and level of normalized earnings, the bank stocks will
respond accordingly, both positively as well as negatively. Our top long picks on a
normalized EPS basis are CYN, CMA, and PVTB. See pages 5-6 on normal EPS.
• A Near-Term Positive Catalyst: Bank Failures. Many stocks that appear cheap on
normalized EPS may permanently remain that way in light of the FDIC now pegging
reserve fund losses at $100 billion tied to bank failures. One of the strongest nearterm
catalysts however relate to the relatively stronger players nicely positioned to
take advantage of bank failures with the recent MBFI deal sparking positive market
reaction. Banks that could be positioned nicely to take advantage of FDIC-assisted
transactions are BXS, CYN, FMER, FHN, MTB, PBCT, PVTB, SBNY, and VLY.