As Big Banks Are Scrutinized, Look To These Regionals

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

I have followed the banking industry, and regional banks in particular, most of my adult life. I liked regional banks in particular because I believed I understood how they earned money. They took in cheap depositor cash, and loaned out that money in mortgage, credit card, and commercial loans to create generous net interest income. They supplemented that with modest fee income from those credit cards, mortgage applications, and the like. As long as bad loans were minimal, it was easy to understand and hardly any more difficult for banks to earn profits.

In this month's Atlantic Magazine, Professor Frank Portnoy and Jesse Eisinger took a look at what exists in the here and now, especially with regard to the perceived opacity which inhabits big banks' balance sheets and income statements. Essentially, they ripped to shreds Wells Fargo's (NYSE: WFC) financial reporting in its audited annual report, making note of the trillions of dollars that are at risk. And to think, Wells Fargo, with the glowing support of Warren Buffett, is widely thought of as the nation's most conservative and well run big bank.

But even knowing that many of the problems that led to the 2008 banking crisis exist in different forms today, we can see that big banks are rife with actual financial and legal foibles. JPMorgan Chase (NYSE: JPM), whose CEO Jaime Dimon is regarded as the “smartest banker” in the industry, managed to lose some $6 billion from its London trading desk in early in 2012, at a time when the bank was stating its daily at risk amount, or value at risk, was well under $100 million.

Taking a broader look at the big bank atmosphere, one might wonder with profits at or above the 2006 and 2007 highs, why aren't stock prices. Many of those banks, as well as many regional banks, are selling at or below their tangible book values, implying investors do not believe the quality of banks' reported numbers. There is the Libor scandal, which has already caused fines levied against Barclays (BCS) and UBS Bank (UBS) and still threatens to impair the balance sheets of JPMorgan, Bank of America (BAC), and Deutsche Bank (DB).

Add in the Abacus Scandal that Goldman Sachs (GS) had the lead role in, rigging the investment against the public and in favor of itself, and the long history of civil and administrative penalties paid by Citigroup (C), and it seems none of the big banks are actually concerned about honor or transparency.

Other than the Libor and other recent scandals of these banks, what else do they all have in common? They are all on the list of the Financial Stability Board's opinion of the 29 banks that are still too large, or at least systemically important, to fail.

I am not against the idea of investing in big banks. It is just important to have some respect for what you are getting into before one invests in any of them. I am bullish on Wells Fargo, and almost bullish about Citigroup.

Regional banks are not as simple as they once were, but they hold nowhere near the skeletons in their closets as the big banks have. My favorite types of regional banks are those that struggled greatly in the recession, have struggled to come back, but are showing signs of doing exactly that. Suntrust Bank (STI) and Regions Financial (RF) are two clear examples. Another is BancorpSouth (NYSE: BXS), a Mississippi based regional with about 300 branches mostly in its home state, Alabama, Arkansas, and Tennessee. Its stock price is struggling at less than half its pre recessionary price, but with good reason as earnings are about half of what they were in the middle of last decade.

BancorpSouth is on pace to more than double its earnings in 2012 from 2011, for its best year in the last four. Analysts expect earnings for 2012 of about $91 million, or $0.96 per share, compared with $38 million, or $0.45 per share in 2011. But I see far better days ahead, as the bank begins to expand again its loan portfolio and manages to reduce credit costs further. The $91 million in 2012 earnings will still be only a 0.66 return on assets. As an institution with a long history of averaging about a 1.2% return on assets, BancorpSouth has the chance to double its earnings and stock price, out to mid-decade. I do not like its geographic footprint as much as I do Regions' or SunTrust’s', but for those wanting to take a chance on a bank with a real potential for capital growth, BancorpSouth is an option.

Flagstar Bank (NYSE: FBC), the largest savings bank in the Midwest with about $14 billion in assets, has come a long way since the New York Stock Exchange warned that Flagstar was close to losing its NYSE listing. An October 10:1 reverse stock split got Flagstar's stock price up over $1 per share. The stock price has nearly doubled since October though, on the back of an improving balance sheet and earnings. The balance sheet shed $1.2 billion in commercial loans to CIT Group at the end of 2012. The company has blown through profit estimates the last two quarters, and I look for it again to exceed forecasts of $0.82 per share in the fourth quarter. The economy Flagstar is rooted upon in Southeast Michigan is showing growth in real estate prices and economic activity, and I look for Flagstar to have a stellar 2013. The company is selling for about five times earnings, and I think this company is a winner.

M&T (NYSE: MTB) is another, albeit larger regional bank I will keep my eye on in 2013. M&T has historically been a well-run regional bank. But its pending 2012 purchase of Hudson City Bancorp (HCBK) will change that. It is not often a large purchase not only will be immediately accretive to the acquirer's earnings, but to the purchaser's capital ratios as well. The Hudson City purchase will drive M&T's 2013 earnings up by as much as $1.40 per share, above an already solid bottom line in 2012. That gain of roughly 20% is not reflected in the current price, and I am highly confident that M&T will be a winner in the banking sector, and market overall, in 2013.


StockCroc1 has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo & Company. The Motley Fool owns shares of JPMorgan Chase & Co. and Wells Fargo & Company. 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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