Alan Brochstein suggests taking a look at smaller banks



As 2012 comes to an end, an obvious theme has been the very poor performance of Financial stocks. Through December 19th, the financial stocks in the S&P 500 had declined 23%, clearly the worst sector in the market and sharply behind the 4.2% decline in the S&P 500. For smaller Financial stocks, the damage hasn’t been quite as bad, but the stocks have nonetheless declined in 2011.

My view is that overall pressure on the large banks may be creating an opportunity for smaller ones. Small banks tend to be focused purely on domestic lending. Additionally, many of them didn’t accept TARP loans and were able to preserve their dividends. At a time that investors seem to be focused on dividends and eschewing international exposure, smaller banks may be worth a look for conservative investors.

Regional banks have been struggling lately fundamentally, hurt by low loan demand and low long-term rates. If the economy remains weak and rates remain low, it will likely continue to pressure earnings growth. The regulatory environment worsened with Graham-Dodd, which is another constraint in the near-term but that could hurt their smaller competitors even more over the long-term, providing the opportunity for share-gains or consolidation.

In order to identify some potential candidates to consider, I set up the following screen:

·       Market Cap  > $500mm
·       S&P Quality Rating > B+ (Measure of quality)
·       2011 EPS Growth > 0
·       5-year Dividend Growth Rate > 0

Here are the 10 banks that made the cut, sorted by YTD price return:



Please keep in mind that these are not recommendations. You should do your own research before buying or selling any stock.

While one stock has rallied sharply and two others modestly, most of the stocks are down significantly in 2012. Checking the headquarters, I note that thee of the stocks (First Financial (FFIN), Prosperity (PRSP), and Cullen/Frost (CFR)) are based in Texas, which has had a strong economy. Several others are in nearby states, like Bank of the Ozarks (OZRK) in Arkansas, BancFirst Oklahoma (BANF) in Oklahoma and Iberiabank (IBKC) in Louisiana. CVB Financial (CVBF) is based in California, Northwest Bancshares (NWBI) is based in Pennsylvania, Bank of Hawaii (BOH) is based in Hawaii, and First Niagra (FNFG) is based in New York.

I have highlighted the banks that have an “A” rating. Most of these tend to have very little debt, funded primarily by deposits.

I have also highlighted the dividend yields in excess of 3%, while also calling out FNFG’s very high yield as perhaps a signal of a problem. That company has been very aggressive this year with acquisitions and has issued a lot of stock, including a large deal earlier this month. Lower payout ratios reduce the likelihood that dividends will be cut if earnings come under pressure, and three of the banks pay out less than 50% of net income.

While all of these banks have bucked the trend and increased their dividends over the past five years during challenging times for the industry, four have increased their dividends in excess of 5% per year.

Finally, Price to tangible book can be a helpful indicator of potential value and often is one of the metrics used in acquisitions. While the current environment doesn’t suggest a wave of M&A in the near-term as larger banks struggle with their own challenges, we could see an increase in the appetite for acquisitions as the economy recovers in 2012 or 2013. 5 of the stocks trade at or below 1.5X TBV.

I include CFR in my Conservative Growth/Balanced model portfolio, having added it just recently. In addition to a very conservative bank, the company operates a large asset management company and provides other financial services.  The earnings growth has leveled since 2008, but the forward PE ratio of 14X is near the low-end of the range of 12-17 over the past decade. I expect that the multiple could expand as soon as earnings growth reaccelerates.

Screening is a tool to identify stocks to study more closely for potential investment. In this case, we have identified 10 regional banks that meet several criteria important to conservative investors, including earnings growth, dividend growth and quality (as represented by the Standard & Poor’s rating). Regional banks could round out a diversified portfolio, providing above-market current-income through dividends as well as the potential for capital appreciation should the economy pick up over the next year or two.


Regards,
Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

Disclosure:  Long CFR in a model at Invest By Model

In reading content in the Trader Network, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.

Alan Brochstein maintains a cross-marketing relationship with TradeKing.


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Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Trader Network, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.