April 21 - After two straight years of strong outperformance in bank stocks, the sell-side analyst community has narrowed its focus and recommends buying banks that can separate themselves from the pack.
Banks outperformed the broader markets by 30 percent in 2012 and 2013, rising close to 77 percent during that time period. Bank stocks added to those gains modestly in the first quarter, leaving the group trading at close to 1.80 times tangible book value, up significantly from the beginning of 2012, when bank stocks traded at approximately 1.30 times tangible book value. Much of that growth came during 2013, when the group benefited from investors engaging in an asset sensitive trade, believing that rising interest rates would boost banks' earnings.
Some analysts believed that trade had more than run its course even at the beginning of 2014. In early January, many analysts no longer saw the bank group as cheap, since a number of bank stocks traded in line with or at higher earnings multiples than historical averages despite a challenging fundamental environment.
Several members of the sell-side community said early in 2014 that investors would be better served by picking specific outperformers rather than trading the broad bank group as they had in recent years. For instance, Sterne Agee & Leach analyst Peyton Green noted in a mid-January report that stock selection would be more important in 2014 since the group appears "fairly to slightly overvalued." He said banks that could stand apart likely would have one or more positive characteristics such as a strong organic growth profile, the ability to serve as an opportunistic consolidator or have exposure to faster growing niche business.
Fellow Sterne Agee analyst Brett Rabatin offered a similar recommendation a day later, advising investors to purchase "misunderstood names with potential controversy" or banks with unique growth prospects.
"On the flip side, we see less value in names at present valuations that will benefit from higher short-term interest rates, but have minimal prospects for profitability improvement and modest growth otherwise in the near-term," the analyst wrote in a Jan. 15 report.
Banks with unique stories ultimately did receive the most positive attention from the sell-side community in the first quarter. Analysts also showed favor toward larger banks over their smaller counterparts in the period. SNL tried to highlight where analysts were most bullish on the bank group and looked at the highest concentrations of buy ratings analysts had assigned specific bank stocks and how the ratings dispersion differed by asset size. SNL defined a buy recommendation as a positive rating an analyst can assign a bank stock based on their firm's ratings scale. To achieve an adequate sample size, SNL looked at publicly traded banks and thrifts that had at least seven analysts covering the stock as of March 31.
SNL's analysis found that larger banks fitting that bill received more positive reiterations and upgrades than smaller institutions in the first quarter. The 19 banks with more than $50 billion in assets that had seven or more analysts covering their respective stocks received 22 total upgrades and 467 buy reiterations during the first quarter. The next largest group, which comprised 39 banks with assets between $10 billion and $50 billion, received 26 upgrades and 263 buy reiterations during the first quarter.
The stocks of larger banks did outperform their smaller counterparts in the first quarter, with the SNL Bank and Thrift Large Cap Index rising close to 4%, while the SNL Small and Mid Cap Indexes were nearly flat in the period.
A handful of large banks were also among the top rated bank stocks by the sell-side analyst community when the first quarter came to a close. Five banks with more than $50 billion in assets — JPMorgan Chase & Co., Capital One Financial Corp., Citigroup Inc., Regions Financial Corp. and State Street Corp. — were among the top 20 rated bank stocks based on the highest concentration of buy recommendations to total stock recommendations, assuming at least seven analysts covered the stock.
Banks that are either in the middle of integrating a transformational deal or seen as acquisitive were also featured prominently among the top-rated bank stocks when the first quarter came to a close. First Financial Holdings Inc., which is in the process of integrating its nearly $300 million purchase of First Federal Bank, had more support from the sell-side community than perhaps any other publicly traded bank. All seven analysts covering the stock had a buy, outperform or overweight or another positive rating on shares of First Financial as of March 31.
Many analysts have long been bullish on First Financial's shares, calling the company an above average grower that will maintain its outperformance as it capitalizes on the benefits of its purchase of First Federal. Investors have championed that deal as well, but sold off the company's stock in the wake of its fourth-quarter earnings, which fell short of the Street's expectations. Analysts believe that the company will benefit from securities purchases it made late in the fourth quarter and cost savings from the First Federal deal coming later in 2014, making the miss in the fourth quarter "timing-related," as then Sandler O'Neill analyst Joseph Fenech put it.
"The bottom line fell short of our estimate and Street expectations, which simply is what it is. That said, and while we're not trying to make excuses, timing issues, more than anything else, seem to be the cause," Fenech wrote in a Jan. 30 report shortly after the company's results surfaced.
Shares of First Financial fell close to 7.5 percent in the weeks that followed, while the SNL Bank & Thrift Index fell just shy of 1.5 percent. Analysts saw the sell-off in First Financial shares as either an opportunity to upgrade the stock or reiterate their positive position on shares. Some analysts noted that the weakness in the first two months of 2014 offered investors an attractive entry point into one of the best franchises in the Southeast.
Still, Zions Bancorp. received the most upgrades in the first quarter of any publicly traded bank with at least seven analysts following the company. Three analysts upgraded the stock, with the actions coming in early and mid-February leading up to and following the company's investor day Feb. 13. The analysts highlighted the fact that Zions has an asset sensitive balance sheet and exposure to faster growing markets where economic activity has increased recently.
Shares of Zions initially traded up on the support from the sell-side community, but the company's stock came under pressure in mid-March when the Street and Zions itself seemed caught off guard by its performance in the latest round of stress tests. Analysts had not expected much, if any capital, to be returned to shareholders in the aftermath of the stress tests. Analysts had expected Zions to resubmit its capital plan to regulators after the stress tests since the original submission came before selling certain collateralized debt obligation securities in January and February. However, few, if any, analysts expected Zions to end up issuing additional common equity as a result of the exercise.
Some analysts viewed the sell-off in Zions shares as a buying opportunity for investors since much of the bullish thesis remained intact. D.A. Davidson analyst Gary Tenner, who upgraded shares of Zions to "buy" in early February, reiterated his investment opinion on the stock in the wake of the stress tests and said the company remains an "inexpensive option on stronger loan growth and higher interest rates."
"The stock may be range bound over the short term as the market waits for the results of the resubmitted capital plan, but we think a resolution could prove a catalyst as the company should then be better positioned for future stress tests," Tenner wrote in a March 31 report.
Analysts believe the market might have to wait for results later in 2014 for real catalysts to trade the bank group broadly as well. In a preview of banks' earnings season, which kicked off last week, Evercore's bank research team noted in an April 6 report that the first quarter would be a "frozen" quarter, given seasonally weak top line trends and higher compensation expenses. The analysts, though, said they remain positive on the sector since they believe large-cap bank stocks still trade at attractive valuations and expect long-term improvements in long growth, capital deployment and higher M&A activity.
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