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I expect income-oriented investors to increase their holdings of financial stocks in the wake of the upcoming CCAR results in March 2013; similar to the March 2012 effect. Credit Suisse (NYSE:CS) expects aggregate capital deployment levels for financial stocks to increase by 63% in 2013. Among other regional banks, Credit Suisse thinks Regions Financial (NYSE:RF) and SunTrust Banks (NYSE:STI) are candidates for the largest increase in dividend payouts. Both banks had depressed payouts in 2012. Therefore, a recovery through 2013 would be attractive for income investors. I recommend investors buy Regions Financial and SunTrust Banks.

In my earlier report on the upcoming Fed's stress test for the 19 large financial institutions we saw how the Fed relaxed the domestic scenarios, while building more stressful international scenarios. The new international scenarios will disadvantage Citigroup (NYSE:C), which has a large international presence, particularly in Asia. The Fed is assuming a severe slowdown in China this time around for its stress test. Today, I will attempt to look at the capital positions of Regions Financial and SunTrust Banks and the chances of an increase in their capital deployment.

The upcoming stress test requires the financial institutions to show they can survive a recession. Following are some of the Fed's assumptions:

  1. Unemployment rises more than 400 basis points,
  2. Equity prices fall more than 50%,
  3. GDP declines 5% and
  4. Commercial and residential property values fall more than 20%

Regions Financial

With a market cap of $9.1 billion, Regions Financial operates as a regional bank in the U.S. financial sector, providing most of its services to the Southern, Midwestern and Texas regions.

The bank reported better-than-expected results when it reported its performance for the third quarter. Earnings per share of $0.22 exceeded its estimate by 7.6%, while the top line of $1.4 billion met its expectations. On average the bank generates 40% of its revenue from fee income, while the rest comes from interest income.

Regions Financial remained moderately sensitive to gradual and instantaneous changes in the interest rates. Given a 100 basis point instantaneous increase in the interest rates, the bank's net interest income would increase by $255 million. A 50 basis point instantaneous decline in the rates will result in a $128 million decrease in the net interest income.

A gradual 100 basis points decline in the interest rates will result in a $207 million increase in the net interest income. A gradual decrease of 50 basis points in the rates will lead to a $105 million decrease in the net interest income.

The bank estimates its Basel III tier 1 capital ratio at 8.7% at the end of the third quarter. This is 20 basis points above the regulatory requirement of 8.5%. At the end of the same quarter its Basel I tier 1 capital ratio was 10.5%, while tier 1 common capital ratio was 10.84%. Regions Financial is currently trading below its book value. Therefore, share repurchase is the most attractive option, particularly in the light Fed's 30% dividend cap.

SunTrust Banks

SunTrust Banks has a market cap of over $14 billion and operates largely within Florida and Georgia, providing a diversified range of financial products to consumers and corporate clients.

SunTrust Banks' results were impressive for the third quarter. The bottom line of $0.58 was far above estimates of $0.19 per share, while the top line of $1.9 billion remained behind its expectation. The results were driven by favorable trends in core business. The net interest income for the third quarter surged marginally compared with the same quarter of the previous year. Much of the improvement was a result of a decline in interest expense. Non-interest income surged over 180% to $2.54 billion over the same time period. The improvement was a result of higher gains on net securities. The bottom line surged significantly to $1.06 billion at the end of the most recent quarter.

The tier 1 common ratio for SunTrust Banks at the end of the third quarter was 9.82%, an improvement from 9.22% at the end of the fourth quarter of the prior year. The bank maintained tier 1 capital ratio of 10.57%, while it had a total capital ratio of 12.95%. Like Regions Financial, SunTrust Banks trades below its book value, making the option of share repurchase attractive.

Valuations

Regions Financial trades at 0.61 times to its third-quarter book value, while SunTrust Banks trades at 0.7 times book value. Comparatively, banks with expensive valuations and excess capital might consider merger and acquisition as a more attractive option. BB&T Corp (NYSE:BBT) and Fifth Third Bancorp (NASDAQ:FITB) are among the regional banks with expensive valuations. BBT trades at 1.03 book value multiple, while FITB trades at 0.95 times.

Source: Regional Banks To Buy On Expected Capital Deployment