Ten Reasons Bank Stocks Can Keep Outperforming in 2014

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Bank stocks had a stellar return in 2013, generally outperforming even the 26.5% return on the Dow Jones Industrial Average and the 29.6% gain in the S&P 500 index. We recently highlighted our own 2014 bullish and bearish cases for the likes of J.P. Morgan Chase & Co. (NYSE: JPM) and Bank of America Corp. (NYSE: BAC), and now we have a Merrill Lynch report out with 10 reasons that banks can keep outperforming the broad market in 2014.

Merrill Lynch went as far as to say that it sees its top picks in bank stocks nearly doubling the returns of the S&P 500 in 2014. Those picks include Citigroup Inc. (NYSE: C), J.P. Morgan Chase & Co. (NYSE: JPM) and Wells Fargo & Co. (NYSE: WFC). Merrill Lynch does not cover Bank of America Corp. (NYSE: BAC), as is customary that bank analysts do not follow their own parent company. The call’s first look is that bank stocks have an implied 12% upside, versus closer to 9% for the S&P 500, while the firm’s top picks imply a median upside potential of 17%.

The research team prefers banks where multiple rerating has lagged. It also favors those where the capital return is rising, credit leverage remains and with niche growth plays ahead.

The top picks for large regional banks are Regions Financial Corp. (NYSE: RF) and BB&T Corp. (NYSE: BBT). Merrill Lynch’s top picks of the smaller regionals: First Republic Bank, SVB Financial, First Bancorp (NYSE: FBP) and Texas Capital BancShares Inc. (NASDAQ: TCBI). The team believes that mega-cap banks offer the most value for investors, and the targets have been raised as follows:

  • Citigroup target raised to $65 from $61 (versus a $54.81 close)
  • J.P. Morgan target maintained at $65 (versus a $58.87 close)
  • Wells Fargo target raised to $50 from $47 (versus a $45.92 close)

Regions Financial Corp. (NYSE: RF) saw its $12 target remain in place, versus a $10.25 close. BB&T Corp.’s (NYSE: BBT) target price was raised to $44 from $38, versus a $38.14 closing price. More reasoning behind the call is that the Merrill Lynch team feels that multiple expansion can continue from relatively levels now, and the steepening yield curve will continue to buoy these stocks. The team said”

In the 1990s, nearly 80% of the rally from trough occurred in the second half of an 8-year recovery. In this current mid-cycle, we think there is further material upside in banks, as higher rates (especially from historical lows) and stronger loan growth replace M&A as the catalyst this time around.

A summary of the ten reasons that bank stocks can keep outperforming is as follows:

  1. Better macro + mid-cycle = good for stocks.
  2. Multiple expansion may not be over. Mega cap multiple expansion has lagged the most. Abating uncertainty over regulatory and litigation concerns should help.
  3. A steepening yield curve will help stocks — now is not too early to own bank stocks.
  4. Declining risk will help multiples (price to tangible book value).
  5. Stable earnings revision trends heading into 2014 — solid GDP could drive EPS upside from loan growth and capital markets.
  6. Stocks outperform when credit is stable. Abating balance sheet risk and unlikelihood of negative credit surprises …
  7. U.S. active managers are still underweight — 8% underweight implies incremental buyers on the sidelines.
  8. Capital return will accelerate at CCAR banks. Expect capital payout for large-caps to rise to 62% of earnings per share from 42% in 2014.
  9. There is always a premium for “niche” growth. Small-cap portfolio managers should not be scared of high price-to-earnings (P/E) ratios due to growth opportunities.
  10. The M&A logjam in smaller-cap banks could finally break.

Texas Capital BancShares Inc. (NASDAQ: TCBI) trades at a discount to high-growth peers at 15.5 times 2015 expected earnings, versus 18 times the peer median. The team reiterated its Buy rating, and its revised price target of $68 implies 10% upside. Be advised that the consensus price target is lower at $61.76.

First Bancorp (NYSE: FBP) is the most unknown of the group, but Merrill Lynch sees 55% upside as the $5.80 close compares to a $9 price target. The consensus target is $817, but the street-high target is even higher at $11 on this one. Its 52-week range is $4.69 to $8.70.

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