Morgan Stanley analysts Ken Zerbe, Josh Wheeler, Jonathan Katz, and Giselle Cheung published a report entitled “Mid Cap Banks” on December 9, 2011. They believe that these banks are currently “in a much better position than the market gives them credit for”. These banks have little, if any, exposure to the European crisis and have been “moving on macro events”. Overall, net interest margin for most of the banks is expected to decrease whereas net interest income is likely to remain stable. Loan growth may improve slightly and the share buybacks is going to triple.
We are discussing the stocks in a series of articles. This is the second (see Part 1).
Cullen/Frost Bankers (CFR) has been given an underweight rating by Morgan Stanley (MS) despite the company’s solid credit quality. Its net interest margin will continue to decline due to a decrease in asset yields and an increase in loan run-offs. The average loan balances of the company decreased by 0.5% last quarter and it has a relatively weak loan demand. Morgan Stanley expects loan growth to be restrained due to a large competition and deterioration in prices. Earlier this year, it acquired Clark Benefit Group but MS believes that current valuations of other acquisitions are too high. Shares of the company are currently trading at $52.5 and are expected to reach $55 by the end of 2012.
East West Bancorp (EWBC) has been given an overweight rating by Morgan Stanley. The bank is reporting a strong growth in its Commercial and Industrial segment due to its connections with China. It has invested its Commercial and Industrial platform, resulting in an increase in its market share. The management of the bank is looking to decrease net interest margin from 3.98% down to 3.9%. It has increased its quarterly dividend to $0.05, at the start of the second half of this year. Morgan Stanley expects quarterly dividends double as the company continues to buy back its shares next year. Shares of the company are currently trading at $19.5 and are expected to go north of $26 by the end of next year. Earnings per share of $0.4 are expected by the end of 2011.
Fifth Third (FITB) has been given an overweight rating by Morgan Stanley. It has one of the lowest Tier 1 common ratios of 9.3%. Morgan Stanley expects a loan growth of 0.8-1.4% per quarter for next year, because of an ongoing manufacturing and auto recovery in the Midwest. With high return-fee businesses, the bank is expected to generate strong profitability. Fifth Third has one of the largest reserve ratios among the midcap banks. Shares of the company are currently trading at $12.5 and are expected to go north of $17 by the end of next year. Its return-on-equity and return-on-asset values are expected to increase by 2% and 0.9% by 2015 due to a strong base of fee revenue, efficient capital management, and an expected increase in net interest margin in the coming years.
First Horizon National (FHN) has been given an overweight rating by Morgan Stanley. The bank has drastically reduced its expenses by $88 million and is expecting to decrease it further by $27 million, at the end of this year. The management of the bank is expecting a 60-65% efficiency ratio in 2013. Net interest margin is likely to decline slightly due to the replacement of lower-yielding non-strategic loans by core loans. First Horizon National is not looking for any mergers and acquisitions but has set aside $100 million for stock repurchasing. Shares of the company are currently trading at $7.8 and are expected to go north of $11 by the end of 2012.
First Republic Bank (FRC) has been assigned an equal-weight rating by Morgan Stanley, despite having one of the best loan growth outlooks amongst the mid-cap banks. With this strong loan growth, net interest income is expected to grow by 10% while the net interest margin is likely to decline. The wealth management platform of the company has a great opportunity to grow because it is currently operating below scale. The credit quality of the bank is pristine due to conservative underwriting. Morgan Stanley expects the bank to have a lower core net interest margin, a higher efficiency ratio, and a smaller mixture of fee revenues. Shares of the company are currently trading at $30.8 and are expected to go north of $33 by the end of next year. Robert Caruso’s Select Equity Group had $77 million in FRC at the end of the third quarter.
Hancock Holdings (HBHC), a bank with strong capital ratios, given an equal-weight rating by Morgan Stanley. It is expected to see a loan growth of 2%, which is below its peers. More than $0.8 billion of the loans are legacy construction and indirect consumer loans which are going to decline over the next year. Hancock Holdings have recently acquired Whitney and are looking to decrease their costs by $134 million. Morgan Stanley expects the margins to remain stable over the coming year due to $900 million in excess liquidity. The widening of the Panama Canal is likely to be beneficial for the company. Shares of Hancock Holdings are currently trading at $32 and are expected to reach $37 by the end of next year. Ken Griffin’s Citadel Investment Group had $26 million in HBHC at the end of September.
Hudson City Bancorp (HCBK) has been given an equal-weight rating by Morgan Stanley. An increase in the interest rate and greater mortgage demand will help Hudson City Bancorp to grow but these effects are not likely to occur in the short-term. Average loans have fallen by 0.3%, with net interest margin also seeing a decline. The company’s conservative underwriting has kept charge-offs relatively low. It has also entered into a Memorandum of Understanding with the OCC, resulting in slightly higher expenses. Shares of the company are currently trading at $6 and are expected to reach $8 by the end of next year. The company has a payout ratio of 47%. Billionaire Jim Simons’ Renaissance Technologies had the largest position in HCBK among the 350+ hedge funds we are tracking.
Disclosure: I am long MS.