Activist investing and special situations.

Sorting Through the Regionals

Added on by Lee Ho Fook.
fifth third.jpg

Be sure to check out our detailed stock analysis (click here). Standard & Poor's has a positive outlook for regional banks, as do I. These banks tend to have less exposure to international concerns and also are purer plays on deposits and consumer/small business economic health, whereas the exposure of mega-banks can be susceptible to trading and other "unplanned" losses.

The regionals should see positive performance going forward on the back of home refinancing and gains on loans. According to Fitch, at the end of third quarter 2012, the median return on assets (ROA) for mid-tier regional banks was 0.93%. Meanwhile, all five banks below have ROAs in excess of the median. More specially, my two top picks, Regions Financial (NYSE:RF) and BB&T (NYSE: BBT), have ROAs of 1.91% and 1.13%, respectively. 

S&P expects that regional banks will see an 8% increase in net income on flat net revenues, on the back of a 2.0% increase in net interest income. The regional segment of banks also appears to be well-capitalized according to S&P, with an average Tier 1 capital to risk-weighted assets ratio of 12.5% at year end.

My Top Picks

Regions Financial and BB&T appear to be two of the best positioned regional banks in the industry, both having their own respective strengths. Although Regions won't make you rich with dividends, with a current dividend yield of 0.5%, it does have room to grow via both geographical and multiple expansion. Regions operates throughout the South, Midwest and Texas, and also trades at the lowest price to book ratio of the five stocks listed at 0.75 times. The bank also boasts the lowest debt to capital ratio at 32%. 

Regions grew its net interest margin to 3.10% in the fourth quarter, which is still pretty positive when comparing the sub-3% net interest margin of major banks like Bank of America andJPMorgan. Although Regions is a relatively unknown bank, it ranks tenth in domestic deposit market share, owning 1.54% of the market. 

Regions' big focus is to internally generate capital and sell off non-banking assets. This helped the bank see fourth quarter net charge-offs down 58% year to year. The bank also sold off its Morgan Keegan brokerage unit for $1.2 billion, helping it pay off its $3.4 billion TARP obligation.

At the end of 2012, Regions had an impressive 39 hedge funds long the stock, with billionaire Ken Griffin's Citadel Investment Group having the largest position in the bank, worth close to $192 million (check out how other hedge funds are trading Regions).

BB&T is one of the more expensive of the five banks with a price to book ratio of 1.11, but it does pay the highest dividend yield at 3.1%, which also happens to only be a 28% payout of earnings. BB&T also commands a 3.9% net interest margin and 67% efficiency ratio, which are both either in line or tops in the industry. The bank has managed to gain 30 basis points in market share over the last five years, now owning 1.83% of the deposits market share, compared to 1.53% in 2007.

BB&T also has an impressively diverse revenue mix, with higher fee income from insurance brokerage services, life insurance, wealth management, and specialized lending. BB&T's big advantage is its dividend yield. Earlier this year the company upped its dividend payment by 15%.

BB&T had much less hedge fund interest at the end of 2012 than Regions, with a total of 27 funds on the long side, but an increase of 17% from the third quarter. This bank, however, has managed to attract impressive hedge fund owners, including billionaires D.E. Shaw, Steve Cohen and George Soros (check out other hedge fund action in BB&T).

Honorable Mentions 

All three of the regional banks below saw marked growth in EPS year over year for 2012, signaling a potential industry turnaround. Huntington Bancshares (NASDAQ: HBAN) is a multi-state diversified regional bank holding company, operating The Huntington National Bank. Although Huntington's solid balance sheet, with a 34% deb to capital ratio, makes it appealing, the bank is the most expensive of the five -- carrying a P/B ratio of 1.12. 

Huntington didn't see as impressive growth year over year in EPS during the fourth quarter. Its 4Q EPS came in at $0.19, compared to the same quarter last year of $0.14. This comes after a third quarter that showed disappointing loan growth, but growth rebounded in the fourth quarter. As well, for the fourth quarter results, nonperforming loans fell 9.5% from the third quarter and 28% from a year ago.

SunTrust Banks (NYSE: STI) is another major regional that pays a small dividend like Regions, yielding 0.7%, but it's also on the cheap side of the industry with a P/B of only 0.75. However, unlike Regions' relatively low debt to capital ratio, SunTrust is at 42%.

The bank is a bit larger than Regions with respect to deposits  owning 1.7% of the deposit market share and coming in at ninth (with BB&T is eighth and Regions tenth). The bank posted fourth quarter earnings of $0.65, compared to fourth quarter 2011's $0.13, again like most peers, well above last year. However, revenue and loan growth was not as impressive and came in at the mid-range of peers.

SunTrust does have an impressive lineup of hedge fund owners, with 37 hedgies owning the stock, but there were some notable sell-offs, including Adage Capital and Lansdowne Partners dumping two of the largest positions.

Fifth Third Bancorp (NASDAQ: FITB) operates in twelve states throughout the Midwestern and Southeastern U.S. This bank is in line with BB&T on a debt to capital (51%) and P/B basis (1.06). Like many of the other banks, Fifth Third also posted a strong fourth quarter. The bank managed to post 2012 EPS of $1.66, compared to the $1.18 for the same quarter last year, with mortgage banking driving fee income. Yet, its net interest margin fell 0.07% from the third quarter. However, many of Fifth Third's recent earnings results have been elevated (artificially) by releases of reserves. What's more is that Fifth Third's year-end Tier 1 capital ratio was 10.65%, which is below major peers.

Don't Be Fooled

Regions is one of the cheapest regional banks around and it also has a top-notch balance sheet. Meanwhile, other top industry pick BB&T is not quite as cheap but offers investors a 3.1% dividend yield and has one of the best returns on equity in the industry at 10.5%. I think these two banks are a couple of the top regional bank stocks, but the other three banks could be solid investment choices with a bit of work.