Much has been said about the advantages regional banks have over larger banks in terms of regulatory headwinds. As a value investor who is sympathetic to the efficient markets hypothesis, I believe that this is already common knowledge and has thus been fairly factored into the stock price. Moreover, regulations come and go - companies adjust accordingly and greater scale often, although not always, means better ability to adapt to the whims of politics. At the same time, I also believe that the fear surrounding large banks has significantly discounted solid fundamentals and depressed valuation. BB&T Corporation (BBT) and SunTrust (STI) are two regional banks that have a "hold" rating on the Street, a sentiment that I more or less agree with.
From a multiples perspective, both companies are trading at the high end of financials. BB&T trades at a respective 14.7x and 9.7x past and forward earnings while SunTrust trades at a respective 16.1x and 8.5x past and forward earnings. While BBT has a dividend yield that is 160 basis points higher than that of SunTrust, the Fed has signaled apprehension over regional banks with payout ratios greater than 30%. This remains a concern for investors who were hopeful about regulatory arbitrage.
On the positive side, at the third quarter earnings call, BB&T Chairman and CEO Kelly King was very candid about stellar performance:
We think it's a very strong quarter. In fact, it's the best quarter we've had in 3 years. So we're pretty pleased. ...
So net income available to shareholders totaled $366 million, which is up 74.3% versus third quarter of '10. EPS was $0.52, up 73.3% versus Q3 '10. And if you look at versus Q2, we made $0.44, so it's up an annualized 72%, so very strong. And I would just point out with regard to earnings in general, as a highlight, that we did start in the third quarter an expense and revenue optimization process.
We're basically -- we're asking all of our business leaders to reconceptualize their businesses, recognize, and we think we're in for a relatively protracted period of somewhat slow growth in the overall economy. And so we're really taking a hard look at our revenues and expenses and -- but more from a conceptualization point of view versus an absolute cut perspective. So we're pretty optimistic about what that will do in future periods with regard to earnings improvement.
Aside from the strong earnings, it was noteworthy that the company is willing to adapt to a challenging environment instead of trying to doubt it and hope operations work out alright. GDP grow rates are slow and stagnating more than many economists expected, but are not indicative of a recession.
Management has, accordingly, reiterated fourth quarter guidance: NIM will be around 4% and NPAs may decline by as much as 10%. In addition, average total HFI loan growth may reach a high of 6%. At the same time, greater credit costs and less purchase accounting accretion will dilute earnings.
Consensus estimates for BB&T's EPS are that it will grow by 55.2% to $1.80 in 2011 and then by 31.7% and 19.4% in the following two years. Assuming a multiple of 13x and a conservative 2012 EPS of $2.31, the rough intrinsic value of the stock is $30.03, implying 29.8% upside. If the multiple were to decline to 8.5x and the 2012 EPS turns out to be 9.3% below the consensus at $2.15, the stock would fall by 21%. More attractive risk/reward exists in larger-scale financials.
Meanwhile, SunTrust will incur mortgage repurchase costs that are meaningfully above recent quarters. The cumulative loss rate has been upwards of 30%, and I do not anticipate much volatility around that rate, given a stagnant economy. Due to this, only about 5% of the shares will be repurchased - lower than what some risk-averse investors may have hoped for. While a lower NIM gives me pause, I am optimistic about Robinson Humphrey and the level of decline in loan loss reserves.
Consensus estimates for SunTrust's EPS are that it will turn positive at $1.13 in 2011 and then grow by 69.9% and 40.6% in the following two years. Assuming a multiple of 11x and a conservative 2012 EPS of $1.85, the rough intrinsic value of the stock is $20.35, implying 24.3% upside. However, if the multiple were to decline to 7x and 2012 EPS turns out to be 7.8% below the consensus at $12.39, the stock would fall by 24.3%. In agreement with the Street consensus, I rate both firms a "hold."