Bank Waters Will Remain Choppy

Ken Usdin is a managing director in the equity research department for Jefferies & Co. in New York, where he covers large regionals such as Fifth Third Bancorp and BB&T Corp.  In this longer version of an interview that appeared in Bank Director magazine’s third quarter issue, he talks about his predictions for the future of bank stocks, his favorite stock picks and what investors are looking for now.

We’ve seen the banking sector outperform the S&P 500 this year, but bank stocks haven’t done so well since March. Why?

There is not a lot of conviction about the macro-economy and Europe. There are concerns about the election here in the U.S. There is a slowing rate of economic growth in the U.S. I think the market for the bank stocks is going to be pretty choppy for the next several months. The fundamentals are OK but they’re not getting much better.

What are your favorite stocks?

PNC Bank is one of the high quality banks. They have a good growth trajectory—they just bought Royal Bank of Canada’s business in the U.S. so they’ll have some cost savings from that and some growth opportunities as they start to move their people and processes into a new territory for them, which is the Southeast. They have a conservative credit portfolio and [the stock] has a reasonable valuation. I’ve been of the view that you need to have high quality and low quality names. What happens is when people get fearful of the market, people tend to hold onto high quality names and sell their low quality ones. The [low quality] story we like the most is SunTrust Banks. What I like about that is they have a bunch of cost savings programs they’ve implemented. They’ve had a bigger burden relative to other banks from the credit crisis, especially from mortgages. As those costs continue to abate, they’ll have a nice pickup in earnings.

I really thought we would have a better understanding of how regulation is going to affect this sector by now. Do you think you have a better idea of how the Dodd-Frank Act is going to impact the sector than you did a year ago?

The only thing that is consistent from last year is that is going to cost a ton of money. I think the smaller banks are going to feel it bigger than the big banks. It is going to be a long, drawn out process to get compliant. We really just don’t know some of the impact. Costs are going to continue to spiral upwards as it relates to Dodd-Frank.

What are the most important performance metrics for investors and do you see that changing?

Loan growth. One thing people are really focused on is: Can banks grow loans through this tougher environment? Can banks hold up their interest margins? Those are the two most important things that I’m looking for, in terms of being able to sustain an earnings projector.