Everyone heard the phrase "too big to fail" during the most recent financial crisis. The phrase referred to financial institutions that are so large and interconnected that they have become critical cogs in the economy. The idea is that if a "too big to fail" institution were to falter, it could bring down the entire financial system. Therefore, the government needs to step in to help prop up the failing company to prevent systemwide damage.
Large banks are being pressured by multiple sources to decrease their size. For example, Federal Reserve Chairman Ben Bernanke has called "too big to fail" banks a moral hazard, and Mervyn King, the former governor of the Bank of England, has suggested large banks be cut down to size. Former Fed Chairman Alan Greenspan has said that large banking institutions should be broken up by regulators because taxation and fees aren't sufficient to control their influence and growth.
It's not just the "too big to fail" syndrome that hangs over large banks, as readers of my recent article on the 10 most vulnerable retail banks are aware. A study by management consulting group CG42 estimates that the 10 retail banks with the greatest numbers of frustrated customers will lose a combined $92 billion in deposits and $5 billion in revenue over the next year.
Top 10 Retail Banks By Vulnerability
Although these numbers are only projections, the fact remains that many customers of large banks are not happy with their institutions -- and the money pulled out of these banks by dissatisfied customers needs to go somewhere. The obvious destination for these funds would be smaller regional banks.
This idea led me to look into the regional banking sector -- and what I discovered impressed me enough to dig deeper and name my favorite regional bank stock.
I first looked at the SPDR S&P Regional Banking ETF (NYSE: KRE), which is a representation of 78 regional bank stocks. Up 18% this year, this exchange-traded fund is a quasi-equally weighted fund with no single name having an allocation of more than 1.98%. The primary drivers for the regional bank's performance have been an improving economy combined with the potential for rising interest rates.
Banks borrow at lower short-term rates and lend at long-term rates, locking in profits. In other words, the yield curve is steepening with interest rates, which is creating a perfect environment for banks to profit.
Like regional banks, large banks are also poised to benefit from the recovering economy. However, large banks have heavy headwinds like the "too big to fail" dilemma and a large number of unhappy customers. Therefore, I see regional banks as the better long-term play.
My favorite regional bank stock is Bryn Mawr Bank Corp. (Nasdaq: BMTC), parent of the Bryn Mawr Trust Co. Founded in 1889, this Bryn Mawr, Pa.-based company operates 19 branch offices. For the quarter ended June 30, the bank reported record results of $6.3 million in net income and 46 cents in diluted earnings per share, which compares with net income of $5.3 million and diluted EPS of 40 cents a share in the same period last year.
Bryn Mawr Trust recently acquired Davidson Trust and the First Bank of Delaware, which has helped increase earnings. Interest income increased 12.7% during the quarter from $15.9 million in the same period last year. Revenue from wealth management grew 26% to more than $9 million.
As you can see, this little bank is rapidly growing. In the technical picture, shares have been tearing higher since July 1. The price has broken out on the upside after two separate consolidation breakouts.
Risks to Consider: The primary risk with regional banks is the economy. The recovery may slow, and interest rates may stop climbing. Although I firmly think the sector and particularly Bryn Mawr Trust makes solid investing sense right now, anything can happen. Always use stop-loss orders and position size wisely when investing.
Action to Take --> I like Bryn Mawr Trust right now as a momentum purchase. My target price is $35 a share within the year.