5 Regional Banks Headed for a Turnaround

The banking industry still has a rocky road ahead of it as it struggles to shake the hangover headache from the financial meltdown that tipped the U.S. economy into recession.

A quick check of the Federal Deposit Insurance Corp.’s website paints a schizophrenic picture of the industry’s health:

  • The roster of failed banks this year is rising as the credit crisis continues to play out, with 118 going under through August, compared with the 140 that were shuttered in all of 2009.
  • The number of banks still at risk to fail increased to 11% of FDIC-insured institutions, the agency reported recently. The “problem” bank list is at its highest level since 1992, rising to 829 from 775 in the same quarter the year before.
  • While loan-loss reserves declined for the first time since late 2006, nearly two-thirds of banks increased their reserves in the period. Still, total reserves fell -4.5% or $11.8 billion, as many large banks cut back on their loan-loss provisions.
  • Yet the banking industry had $21.6 billion in profits for the three months ended June 30th, significantly better than the net loss of $4.4 billion in the second quarter of 2009.

FDIC Chairman Sheila Bair warned: “Given economic uncertainties, we believe all banks should continue to exercise caution and maintain strong reserves.”

For some who invest in financial services stocks, traditionally it’s the “too big to fail” blue-chip banks or nothing. And while the big boys are turning profits again, flying below the radar through the maelstrom of the meltdown are some well-managed regional banks. They steered clear of many of the problems that got so many of their brethren, big and small, into trouble.

According to Goldman Sachs, there’s been a -10% drop in bank loans in the past two years, one of the biggest contractions seen in more than three decades. That means banks wishing to grow, must do so by acquiring other banks. This sets up a scenario for takeovers and continued consolidation, which can lead to a tidy profit for investors.

Let’s take a look at five regional banks, in no particular order, that continue to hold their own despite the sluggish recovery and shaky credit conditions. All generally operate in different geographical regions:

Huntington Bancshares (Nasdaq: HBAN) is based in the heart of the rust belt — Columbus, Ohio — a particularly notable region with some solid banks showing potential for growth as the economy recovers.

Founded in 1866, Huntington operates more than 600 banking offices, including one in Hong Kong. However, it has stuck mostly to Ohio and the surrounding states, and has clung to commercial lending in troubled times — offering a recent commitment as a source of capital for small businesses.

The company delivered a surprise profit of $10.4 million in the most recent quarter, and has a decent 12.5% Tier 1 capital ratio, a measure of strength used by regulators.

Hudson City Bancorp (Nasdaq: HCBK), with headquarters in Paramus, N.J., has 131 branches in the New York metropolitan area. Hudson City has delivered consistent earnings the past four quarters, and shows an attractive dividend yield of about 5.0% and a P/E ratio of 10.6.

Consistency is the name of the game for Hudson City, and research during the past several years shows that reported earnings are almost always right on target, hitting expected estimates — something almost unheard of given the fluid conditions in the banking industry during the financial crisis.

Analysts appear to find the bank’s loan portfolio appealing, and the name of its primary subsidiary — Hudson City Savings Bank — expresses its emphasis on savings, residential mortgages and other consumer services.

SunTrust Banks (NYSE: STI)
is an Atlanta-based bank, a super-regional with 1,675 branches throughout the Southeast. Not exactly a tiny regional, SunTrust is the 10th-largest U.S. bank, with $170.7 billion in assets, according to SNL Financial.

Hanging over its head is $2.5 billion in TARP money that has to go back to Uncle Sam, so analysts have a mixed view of its potential for investors. With the Southeast being its home base, SunTrust has struggled with troubled loans in Florida and elsewhere. One point in its favor is that SunTrust has lapped up failed institutions during the past two years, broadening its operating base and possibly positioning for the day when the recovery really does take place and consistent economic growth reappears.

Zions Bancorporation (Nasdaq: ZION)
is headquartered in Salt Lake City, operating 500 offices in nine states. Its Tier 1 capital ratio is about 12.6%, which is far above the 5% level that regulators want to see.

But what happened in August? Shares declined -17% after reporting a $135 million second-quarter loss, which came on top of a $24 million first-quarter loss. Not pretty. And there is $1.5 billion in TARP money that has to go back to the government. 

Many analysts who follow Zions rate the stock a “hold,” with expectations that it’ll return to profitability in 2011. This could be one to consider to buy while it hovers closer to its 52-week low than to its high.

Webster Financial Corp. (NYSE: WBS) is based in Waterbury, Conn., and has about 180 branches in Connecticut, Massachusetts, New York and Rhode Island. The bank returned to profitability in the second quarter, reversing the loss seen the year before. Revenue grew +28% and Webster reported that it again shrank its loan-loss provisions, to $32 million from $43 million the prior quarter, and from $85 million in the year-ago period.

Rumors have been floating all summer that Webster Financial is primed for a takeover, and Richard Bove of Rochdale Securities just released a list of 17 banks that could be bought out after screening 62 banks with more than $10 billion in assets. Webster was on his short list. One potential acquirer is First Niagara Financial (Nasdaq: FNFG), which has made some inroads in the Connecticut market.

With the announcement of the Basel III reforms — which is expected to force many European banks to raise more capital — the verdict on long-term possible effects of the new rules on U.S. firms is still out. The general feeling is that big U.S. financial services companies already are in compliance on the accord’s main tenet — a 7% Tier 1 common equity ratio, 3.5 times the current 2% requirement.  [See: How the New 7% Rule Could Affect Your Bank]

But how about our banks listed above? A Sanford Bernstein analyst quickly upgraded Huntington and Zions, noting that they’re in compliance — Huntington is at 12%, while Zions is at 10.5%. Hudson City Bancorp is a tad lower, at 7.6%, while SunTrust is close to 13% and Webster Financial reported at mid-year an improvement to 8.1%.

Action to Take –> Talk of a double-dip recession by some analysts might scare some investors to the sidelines, but it could be a good time to start shopping around for well-managed, profitable banks that are operating quietly in places like rust belt Ohio or conservative Salt Lake City.

Trying to find the right play is still somewhat of an unpredictable proposition. But if you use the banks listed above as a starting point for further research, a modest position in one or two of these names could pay off big.