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Buying bank stocks during periods of economic weakness has historically proven to be a winning strategy. Banks are one of the types of companies most leveraged to the economic cycle.

I purchased shares in Wells Fargo (NYSE:WFC) during the worst of the downturn in early 2009 and that investment has risen sharply. In evaluating other investments in this sector I am drawn to the smaller regional banks. As a rule I prefer to select small to mid size companies since they are often more efficiently managed, can be more shareholder friendly and are covered by fewer analysts. There is a good chance that the banking industry will see consolidation coming out of this period and regionals could be takeover targets. Looking at the regionals I see three types of scenarios. There are a number where the stock price has fully recovered to pre-recession levels. Another group with poor quality fundamentals remains at very depressed prices. The third group has seen some partial recovery in price and is seeing improving underlying business conditions. I have selected three banks from this third group as having good prospects for price improvement without taking on excessive risk. All three pass my criteria for financial strength and capital base.

My first selection is Sterling Bancorp (NYSE:STL). Sterling has operated in the New York Metro area for over 80 years. Sterling’s clientele includes many small and mid sized businesses that have suffered during the recession. But conditions for this group should improve as the economic recovery continues. The company did take TARP funds but expects to repay those in the next 12 months according to comments made during its latest earnings conference call. STL reported a loss in its most recent quarter due to management choice to accelerate the resolution on non-accrual loans primarily in the lease financing area. But management commented that “as a result, our non-accruals at the end of the 2010 third quarter were at the lowest point in three years, essentially returning to pre-recession levels.”
STL currently trades at about 1.5x book value. Prior to the recession it traded closer to 2.3x book. One would expect that both book value and the ratio to book value should increase as the economy recovers. The company‘s dividend is currently 3.5%. STL did cut its dividend in 2009 and future dividend increases are a possibility as the recovery continues.
My second selection is Heartland Financial (NASDAQ:HTLF). Heartland traces its history back 30 years to the organization of Heartland Bancorp in Dubuque, Iowa. The company currently has operations in Iowa, Illinois, Minnesota and Wisconsin as well as several Western states. The midwest is experiencing strong demand for its agricultural products in the presence of ever increasing worldwide demand for food. The price of farmland is rising. Dennis Gartman of the Gartman Letter has commented a couple of times on CNBC that an interesting way to invest in the agricultural boom would be to invest in a Midwestern regional bank, mentioning somewhat facetiously to look in Keokuk, Iowa. Well Heartland does have a branch in Keokuk.
Heartland is currently trading at about 1.2x book value. Prior to the recession HTLF traded closer to 1.8x.book. HTLF reported significantly improving conditions in its most recent quarter with EPS coming in at 0.34 vs. 0.13 in the prior year quarter. Heartland’s current dividend rate is 2.3%.
My final selection is FNB Corporation (NYSE:FNB), headquartered in Hemtiage, Pa. FNB was chartered in 1864 and has a long history as a successful business. FNB’s operations go beyond traditional banking into consumer finance, wealth management and insurance. The company has branches principally in Pennsylvania and Ohio but also has some exposure to land related loans in Florida.
FNB is currently selling at about 1.1x book value. Prior to the recession it traded at 2x book. In the most recent quarter EPS were down slightly (0.15 vs. 0.16 prior year) but the company was pleased with growth in deposits and loans. FNB could be a beneficiary as Pennsylvania sees new income growth coming from Marcellus shale energy production. FNB’s current dividend payout is 4.5%. The company cut its dividend in half in 2009. Dividend increases could occur as business conditions improve.
Disclosure: I hold positions in STL, HTLF and FNB in individual accounts and accounts managed for Freedom Mountain Investments.
Source: Three Regional Banks to Consider for the New Year