PNC Financial Services (PNC), SunTrust Banks, Inc. (STI): Two Financial Stocks to Buy, 1 to Avoid

The interest rate environment and loan growth are among the key determinants of the net interest margin of a bank. Due to low interest rates and macroeconomic conditions, 2013 may be a tough year for banking. Enhanced capital regulations resulted in higher regulatory costs, which in turn are pressurizing the banking efficiency ratio. This growing regulatory cost has more impact on smaller banks’ margins as compared to mega banks. However, some smaller regional banks have managed their expenses efficiently, leading me to believe that they will outperform in 2013.

Expense management is a part of Regions’ culture

For the first quarter ended march 2013, Regions Financial Corporation (NYSE:RF)  reported a net income of $327 million, or earnings per share of $0.23. Net interest income was $798 million, down 2% from last year due to decrease in earnings assets while non interest income was $501 million. In the previous quarter, total funding cost improved to 45 bps, down from 20 bps year ago. Due to ongoing efforts to manage expenses, non-interest expense fell 8% over the previous quarter.

In the previous quarter, mortgage income decreased 20% compared to the linked quarter, but indirect auto loan balances demonstrated progress, as they were up 6% from the prior quarter. Despite a decline in mortgage banking activity, the bank benefited from a further decline in its cost of funds, coupled with growth in low cost deposits. The low-cost deposits grew $375 million, whereas the deposit cost plunged 4 bps over the prior quarter. The bank enhanced its Tier 1 capital ratio by 30 bps, reaching 12.3%, and the Tier 1 common ratio improved 40 bps to 11.2%.

Regions Financial Corporation (NYSE:RF) expects a surge in funding costs due to changes in interest rates, which could lead to a contraction in its margin. Strong loan growth and lower cost of funds will be the positive stock price drivers for the future.

In the first quarter of 2013, SunTrust Banks, Inc. (NYSE:STI) reported earnings per share of $0.63, compared to $0.46 a year ago. A net income of $340 million came in 2.9% above the prior quarter’s net income. Better expense management led to 10% reduction of non-interest expense over the previous quarter.

The bank reported a mortgage production income of $159 million, compared to $241 million for the previous quarter. As a result of low mortgage production income, non-interest income of the bank plunged. However, it was partially offset by an upward trend in commercial and industrial loans.