It's Not Too Late to Buy This Regional Bank

Piyush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

More often than not, banking stocks are considered growth plays instead of value plays. This is reasonable, as global financial institutions generally deliver modest but steady returns. Over the last year, however, shares of Regions Financial (NYSE: RF) have risen by an impressive 50% and outperformed most of the popular global banks.

Now that its shares have more than doubled over the last four years, the Street is doubting the sustainability of its rally. There seems to be ample evidence to suggest that Regions Financial can deliver spectacular returns for at least another year, however.

Strong loan originations

To begin with, Regions Financial posted an 8.8% year-over-year decline in its net income in the second quarter of the 2013 fiscal year due to a spike in operating expenses. Despite that, however, RBC Capital Markets upgraded it to a “Buy” rating. One of the reasons behind this bullish outlook is the strong loan originations of $8 billion during the quarter, up 23% compared to the same quarter last year.

Since interest rates finally seem to be trending upwards, most banks are fearing a dip in their loan originations. Regions Financial came out victorious due to its greater exposure to residential mortgage lending, however. During the recent quarter, 53% of its loan originations came from consumers purchasing new homes, as compared to 35% in the same quarter last year. So how does that benefit the bank?

It's worth noting that the rising interest rates seem to be slowing down conditional prepayment rates (CPR) across mortgage lenders. This means that most of the loans originated are being repaid in their assigned and agreed tenures. Since mortgage lending accounts for 84% of Regions Financial’s entire investment portfolio, a dip in CPR amidst rising loan originations means that its amortization revenues will dip but its interest income will soar.

Improving margins

On the operational side, Regional Financial posted a net interest margin of 3.16%. Net interest margin is the difference between lending and borrowing rates, and is mostly determined by the spreads between short and long-term treasury yields. Thanks to the sudden surge of interest rates, the 10-2 year treasury spread has widened by 46% over the last three months.

Regions Financial posted just a 3 basis point increment to its quarterly net interest margin. This leads me to believe that since the interest spread started widening during July, the bank wasn’t able to fully capitalize on the widening curve. Now that interest spreads seem to have stabilized around 2.35%, however, most banks (including Regions Financial) will be able to post a stellar increment in their net interest margins.

Solid fundamentals

Besides Regions Financial, BB&T (NYSE: BBT) and Fifth Third Bancorp (NASDAQ: FITB) are also rapidly-growing regional banks.

Shares of BB&T have risen by nearly 20% over the last year, and UBS estimates that there is another 12-15% room for appreciation. At the current prices, its yield of 2.53% might look attractive, but its price-to-earnings multiple of 14.93 times indicates that its shares are reaching fair value. This coupled with its high debt-to-equity ratio of 100% suggests that there are better investment options available.

Meanwhile, shares of Fifth Third Bancorp have appreciated by nearly 46% over the last year. UBS estimates that its shares can appreciate by another 10%. With a low price-to-earnings multiple of 10.2 times and a high return on investment of 13%, the Midwest bank appears to be a lucrative investment option. Its low net margin of 25% and high debt-to-equity ratio of 52% highlights a mixed set of fundamentals, however.

Shares of Regions Financial have outperformed these peers. The bank enjoys a higher net margin of 30.4%, and operates with an impressive return on investment of 12.5%. Besides that, its debt-to-equity ratio of 33% is lower than the industry average, which altogether highlights a healthy balance sheet. And even after the rally, the low forward price-to-earnings multiple of 11.3 times suggests that its shares are still undervalued.

Final words

Since rising interest rates is an industry-wide advantage, almost all banks will witness margin expansion. Regions Financial seems well poised to outperform most of its banking peers due to its strong loan originations and high net interest margin, however. Investors should also note that it is a regional bank operating with a small but rapidly growing customer base. This leaves ample room for inorganic growth potential. On the back of all the mentioned reasons, I believe that Regions Financial is a compelling buy even after its recent rally.

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Piyush Arora has no position in any stocks mentioned. The Motley Fool owns shares of Fifth Third Bancorp. 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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