US Regional Banks. A good choice for risk averse investors?

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US Regional banks are a good pick for risk averse investors. This is because a lot of them are well capitalized. The financial strength of a bank can be evaluated looking at the Tier 1 capital ratio. The Tier 1 capital is the core measure of a bank’s health: it is the core capital consisting of common stock, retained earnings and can include preferred shares (non-cumulative and non-redeemable). And the Tier 1 capital ratio is a relation of that core capital to the bank’s risk-weighted assets, so it shows the risk profile of the bank. If a bank’s Tier 1 capital ratio falls below the regulatory minimum it may lead to: issuing shares (diluting the shareholder’s stock) or a dividend cut to increase retained earnings. So looking at high Tier 1 ratios could point to healthy banks with safe dividends and less risk of share dilution in the future.

The two regional banks I am going to evaluate in relation to their capital adequacy are: BankUnited (NYSE: BKU) and Capital Bank Financial (NASDAQ: CBF).

- BankUnited is a savings and loan association that was seized by US financial regulators in 2009 in one of the biggest American bank failures (it is estimated it cost the Federal Deposit Insurance Corporation (FDIC) approximately $5 billion) amid the global financial crisis. Later, its control was transferred to a private equity group. It is currently led by John Kanas that has proven track record in building profitable franchises. The bank’s Tier 1 common capital ratio for 2012 is 34.9%, well above the 11.7% average for 2011.

Other aspects that could boost growth include:

  • Herald National Bank’s acquisition in February 2012 could generate a net loan growth in the New York area of about $2 billion annually (Signature Bank (NASDAQ: SBNY) is already growing at this pace).

  • An improvement in Southern Florida’s economy could impact positively as BKU’s business is concentrated in this area (80%).

  • The bank operates with excess capital of approximately $730 million but the deployment of the excess capital is unknown.

  • Extremely solid balance sheet due to: excess capital and loan loss sharing agreement with the FDIC.

The risks that can offset the listed positive aspects are:

  • Management’s inability to develop New York’s expansion strategy.

  • Private equity investors hold the option to pursue a secondary share offering, which could negatively impact the price of the stock.

  • A portfolio reduction in covered loans could adversely affect BKU’s earnings (75% of net interest income is derived from this portfolio).

- Capital Bank Financial is a regional bank holding company, currently led by former Bank of America executives, operating 165 branches in Florida, North Carolina, South Carolina, Tennessee and Virginia. This is the case of another bank bail out in the 2008 financial crisis. The Treasury Department saved the bank from collapse injecting $41 million. In 2010 North American Financial Holdings acquired approximately 85% of the company for $181 million.

The bank’s Tier 1 capital ratio is 20.9% for 2012 displaying a sound financial strength. CBF has showed a good recovery from the financial crisis, especially regarding loan production: it originated a record $253 million of loans in 4Q12 (46% increase vs. 3Q12).

Although numbers are a bit distorted due to North Carolina-based Southern Community’s acquisition in October 2012, let’s see the encouraging features the company presents:

  • The company presents a diversified loan portfolio: 31% commercial RE, 37% commercial, 30% consumer.

  • In 4Q12 total deposits increased to $5.9 billion  due to the acquisition of Southern Community.

  • Cost of deposits declined to 0.49% from 0.58% from quarter to quarter. Mainly due to growth in low-cost core deposits.

However, the company is subject to some risks:

  • Examining some of the key positive points in the last quarter, most of them are improvements related to Southern Community’s acquisition. The company may have to continue acquiring in order to generate the same growth prospects. Management is less positive on future M&A.

  • Legacy credit expenses remain high: other real estate owned (OREO) expenses are elevated, currently at $9 million

Although well capitalized, regional banks have some risks not related to their financial strength as noted above. Between these two banks, I see better prospects for BankUnited than for Capital Bank Financial as it has experienced management, possibility to grow its loan portfolio (New York) and a very sound balance sheet. It all depends on the risks the investor is willing to take.

Damian Illia has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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