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Between August and early December, financial stocks underperformed the market by more than 5 percentage points. The trend seems to have reversed since the beginning of December. Financial Select Sector SPDR (NYSEARCA:XLF) outperformed the SPY by more than 3 percentage points during the past two months.

Last week, KBW analyzed the fourth quarter earnings of 131 banks. Sixty two percent of the banks met or exceeded consensus estimates. There is a tremendous improvement on the earnings side for both small and large cap banks. Operating earnings per share increased 53% year over year for large caps, and 48% for small caps. Operating earnings per share at large banks increased 5% over the previous quarter, which explains XLF’s recent performance. The decline in lending finally stopped in the fourth quarter, whereas return on equity kept improving by an additional 13 bps over the previous quarter.

Cost of doing business is also improving. The ratio of non-performing assets declined by 10 bps during the past quarter, currently standing at 3.33%. Not surprisingly, banks with TARP performed worse than healthier banks. Their non-performing asset ratio was 4.66%. The median ROE for TARP banks was 1.40% vs. the industry ratio of 5.42%. Considering large banks like Citigroup (NYSE:C) and Bank of America (NYSE:BAC) are free from government ownership, they should be doing well compared to last year.

Last month, Second Curve’s Tom Brown, a hedge fund focusing on financial companies, was bullish about JP Morgan (NYSE:JPM) as well. Investors who prefer to diversify should also consider KBW High Dividend Yield Financial Portfolio (NYSEARCA:KBWD), Regional Bank HOLDRs (NYSEARCA:RKH), iShares Dow Jones US Financial Sector (NYSEARCA:IYF), iShares Regional Banks (NYSEARCA:IAT), Vanguard Financials ETF (NYSEARCA:VFH) or iShares Global Financials (NYSEARCA:IXG). We don’t like using leveraged ETFs such as Direxion Daily Financial Bear 3X Shares (NYSEARCA:FAZ) or Direxion Daily Financial Bull 3X (NYSEARCA:FAS) due to their hidden costs.

We track insider transactions in banking stocks. We believe insider purchases in smaller banks are a strong indicator about the health and future prospects of banks. This is especially true when there are several insiders purchasing around the same time. We compiled the list of financial stocks that have at least two insider purchases and managed to meet or exceed consensus earnings estimates:

1. National Penn Bancshares (NASDAQ:NPBC): The company posted 10 cents per share earnings (excluding special items) during the fourth quarter vs. a $2.25 per share loss a year ago. Analysts were expecting 7 cents per share. The company reported a 44% increase in revenue compared to a year ago. Revenue was $21.9 Million.

2. First Niagara Financial Group (NASDAQ:FNFG): First Niagara posted 24 cents per share vs. consensus earnings of 23 cents per share. The company also increased its quarterly dividend to 16 cents, yielding 4.4%.

3. Huntington Bancshares (NASDAQ:HBAN): Excluding a one-time 7 cents per share charge related to TARP repayment, Huntington managed to beat the consensus earnings estimates. Huntington was the second best performer in 2010 in the KBW Bank Index, returning 88%.

4. Bank of Hawaii (NYSE:BOH): Bank of Hawaii reported net income of 84 cents per share during the fourth quarter, beating analyst estimates of 70 cents per share. This is one of the stocks insiders were buying like crazy at the end of January.

5. JP Morgan (JPM): JPM managed to beat the analysts’ $1 per share estimates by delivering $1.12 per share in net income. David C. Novak, the CEO of YUM Brands and also a member of JPM’s board of directors, purchased more than 100,000 shares of JPM.

Source: Five Profitable Bank Stocks Insiders Are Buying