Regional Bank Stocks – This Rally Hinges on Q3 Results

by Dan Burrows | October 15, 2013 11:41 am

U.S. Bancorp (USB[1]) reports quarterly results Wednesday, and what the Big Kahuna of regional bank stocks says about business going forward could very well be the key to whether this subsector of bank stocks maintains its impressive outperformance through year-end.

Regional banks have been clobbering the market this year and even edging out their larger universal bank cousins. The SPDR S&P Regional Banking ETF (KRE[2]) has generated a total return (that’s price appreciation plus dividends) of more than 33% so far in 2013. That bests the S&P 500 by 11 percentage points, and edges out the iShares U.S. Financial Services ETF (IYG[3]) — comprised mostly of big money-center banks — which has a total return of 29% for the year-to-date. See the chart, courtesy of YCharts[4], below:

bank stocks[5]

Too bad the operating environment for bank stocks has changed significantly during the most recent quarter.

Pressure Coming for Regional Bank Stocks?

Higher interest rates are pressuring lending growth and causing a steep decline in mortgage and refinancing activity.

Regional bank stocks, which typically depend on these traditional banking businesses — and much less on capital markets, trading and wealth management — are more likely to feel the pinch.

That’s going to hamper regional banks’ earnings growth, at least relative to the giant universal banks like JPMorgan Chase (JPM[6]), Bank of America (BAC[7]) and Citigroup (C[8]). Analysts at KBW project regional banks to grow earnings per share by 7% this year and by 5% next year. The universal banks, meanwhile, are projected to see EPS growth of 16% and 12% for this year and next.

That puts regional banks quarterly results under the microscope, and Wednesday offers a slew of them. In addition to USB, regional bank reports on tap include PNC Financial (PNC[9]), KeyCorp (KEY[10]), Comerica (CMA[11]) and East West Bancorp (EWBC[12]).

Fortunately for the regional bank stocks and their shareholders, even though lending and mortgage growth is slowing, better credit quality and greater efficiencies can still propel earnings growth.

For example, UBS analysts rate U.S. Bancorp shares at “buy” based on the bank’s ability to take market share and lower its costs as a percentage of operating profit.

Indeed, the higher-profits/lower-revenue theme sums up regional banks for the most recent quarter and beyond. UBS, PNC, Comerica and East West Bancorp all are expected to report higher EPS on sliding sales. Of those four bank stocks reporting Wednesday, only PNC is expect to book profit and revenue gains for all of 2013.

As such, we’ll probably need some beat-and-raise quarters out of regional bank stocks this earnings season if they hope to extend their outperformance through to year-end.

As KBW notes, financials have been outpacing the S&P 500 thanks to stronger earnings growth on both a trailing and forward 12-month basis. However, that gap between bank stocks and the broader market has narrowed substantially.

As a result, analysts believe that relative bank outperformance for the balance of the year hinges on third-quarter earnings — and estimate revisions to the upside.

Bottom Line

Essentially, there’s really no room for USB, PNC and others to miss Street estimates. And they would do well to serve up enough operational optimism to get analysts to lift their outlooks heading into Q4 and beyond, too.

Otherwise, the great rally for regional bank stocks might have run its course for this year.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

  1. USB:
  2. KRE:
  3. IYG:
  4. YCharts:
  5. [Image]:
  6. JPM:
  7. BAC:
  8. C:
  9. PNC:
  10. KEY:
  11. CMA:
  12. EWBC:

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