Investing in a good regional bank stock is not always easy. Bank stocks have complicated financial statements with different ratios and performance thresholds that traditional companies don’t always have. Many investors get into bank stocks because they typically have great dividends, but as we saw during the last financial crisis, that can be cut quickly.
At its core, banking is commodities business that sells money. In a bank’s case, selling money is done by making a loan. As the interest rate on a loan approaches zero and the requirements needed to get the loan dwindle, the ability to sell loans becomes nearly infinite because everyone could use more money.
Of course, giving money away for free does not lead to a profitable business model, especially if costs a bank to get the money in the first place, so banks are constantly adjusting rates, terms and requirements to get the right of risk and profits that best suit management.
Generally, the most profitable banks are both the most efficient and the most effective at minimizing loan losses. The following three midwest regional bank stocks are worth considering to buy based on these criteria.
Regional Bank Stocks to Buy: U.S. Bancorp (USB)
U.S. Bancorp (USB) has outperformed the KBW Bank Index year-to-date by more than 4%. Stock appreciation has been driven by USB’s strong performance that has produced a 1.56% return on assets and a 13% return on equity, both far surpassing its peers’ performance for the same indicators.
USB stock has been able to drive these returns because of its industry-leading efficiency ratio below 50%. Banks with more than $1 billion in assets currently have greater than a 60% efficiency ratio. Couple this with declining net chargeoffs of 3.7% and a 6.2% decline in non-performing assets for the third quarter, and USB shows that it can not only maximize profitability on loans generated but ensure they pay them back.
USB ‘s allowance for credit losses as a percentage of period-end loans was 1.8% for the third quarter and is above the current industry average of 1.5% for banks with greater than $10 billion in assets. This is down from 1.8% in the second quarter and 1.9% for the first quarter, a nice positive trend.
With a consensus stock price that approximates its current trading range, but a dividend yield of 2.2%, USB stock is a strong long-term regional bank stock to buy due to its quality performance.
Regional Bank Stocks to Buy: Fifth Third Bancorp (FITB)
Fifth Third Bancorp (FITB) has struggled this year, returning a loss of nearly 5% compare to the KBW Bank Index, which has returned more than 5%. Fifth Third Bank has been contending with a very challenging environment as its footprint includes some of the nation’s slowest recovering cities.
But even in this challenging environment FITB stock has been able to produce a return on assets of 1.2% and respectable return on equity of just under 10%.
Overall Fifth Third Bank’s fundamentals have been steadily improving with nonperforming assets as a percentage of total assets declining from 2.9% at the end of last year to 2.5% for the third quarter and loan loss reserves as a percentage of loans and leases declining from 1.8% to 1.5% over the same period.
For the third quarter, net interest margin declined from 3.2 to 3.1%, which is in line with the industry average. Fifth Third Bank’s efficiency ratio increased to 62.1% in the third quarter from 58.2% in the second, but management is aiming for an eventual target of 55% and historically has been able to keep it below 60%.
Fifth Third Bank will most likely finish 2014 with only modest loan growth and continued challenged interest rate environment will weigh on earnings but a steeper yield curve in 2015 will lead to rising net interest margin along with increasing non-interest income that should boost earnings above peers as long as expenses are held in check.
FITB stock’s price trading range is about 10% below the consensus stock price target and offers a dividend yield of 2.6% at a 30% payout ratio. Investors should take this year’s lower price as a buying opportunity to get into a bank with improving fundamentals and traditionally strong cost containment.
Regional Bank Stocks to Buy:Huntington Bancshares Incorporated (HBAN)
Huntington Bancshares Incoroporated (HBAN) stock has appreciated year-to-date in line with the KBW Bank Index. Huntington’s return on assets over the trailing 12 months has been just over 1%, and its return on equity has exceeded 10% over the same period.
Huntington’s efficiency ratio has been trending higher, increasing from 60.3% in the third quarter of 2013 to 65.3% for the third quarter of this year, but its allowance for credit losses as a percentage of total loans and leases has declined from 1.7% to 1.5%, showing signs of increasing credit quality.
HBAN stock is trading at a slight discount to the consensus price target and has recently increased its stock dividend by 20% to a forward dividend yield of 2.4% at a 30% payout ratio. HBAN is a regional bank stock has improving asset quality and will benefit from the steepening yield curve in 2015, as well as recovering economies in its key footprint of Ohio and Michigan.
As of this writing, Kenneth Fick did not hold a position in any of the aforementioned securities. Write him at kfick@piercethefog.com or follow him on his blog at www.piercethefog.com.
