As Mortgage Brokers Flounder, Consider Investing in Regional Banks

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Includes: BSRR, CACB, FCBP, FTBK, PB, UNB
by: Erik Dellith

The number of casualties from the reeling subprime mortgage market is growing and investors have become increasingly nervous about shares in the industry. Rather than avoid financial companies altogether, investors would do well to consider regional banks, which face stricter regulations on lending practices.

Mortgage companies and other similar consumer financial institutions are feeling the brunt of the slowing housing market. At least 20 subprime lenders, who give high-interest loans to customers with poor credit, have gone out of business, and unease over the health of the housing market has spilled over to other areas. Lumber futures on the Chicago Mercantile Exchange, for instance, are down about 30 percent from a year ago. There's reason to worry: About one-fifth of new home loans in 2006 were subprime, according to the Mortgage Bankers Association.

Consumer financial companies are taking steps to mitigate the damage from a slowing market. Countrywide Financial Corp. (CFC), one of the largest mortgage lenders in the United States, recently instructed employees to stop offering no-money-down mortgages. Still, Countrywide has already felt some sting. Its net profit margin has contracted from a five-year average of 25.1 percent to 23.4 percent over the trailing 12 months [TTM] and its return on assets [ROA] has slipped from a five-year norm of 1.84 percent to a TTM figure of 1.43 percent. On Monday, the firm warned investors that, even though subprime loans account for just 7 percent of its loan portfolio, there might still be an impact on earnings.

On the whole, the consumer financial services industry has posted earnings growth of nearly 16.4 percent over the last five years. The slowdown in the housing market, however, has contributed to the industry's earnings contraction of more than 17 percent in the TTM span. Regional banks, too, have exposure to the consumer real estate market, but they also have diversified portfolios across different areas, including loans for small businesses and commercial real estate. Even though earnings growth among regional banks has taken a hit of late, earnings in this arena have grown. Earnings per share [EPS] among these lenders climbed about 10.6 percent in the TTM period, a bit slower than the average annual rate of about 15.8 percent for the last five years.

We started our search with the list of 519 regional banks in the Reuters.com stock universe. We focused on the 32 names that recently appeared on at least one Reuters Select stock screen. (Click here for an Excel sheet comparing these 32 banks.)

We then filtered for regional banks that had return on assets [ROA] results above the industry average over both the TTM and five-year periods. This dropped our list down to 10 banks.

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We also wanted some measure of valuation. For this, we turned to the price to earnings (P/E) ratio and filtered for all banks that had lower-than-average results. This left us with only two regional banks.

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The process that we used today worked well to narrow down the list of stocks to a manageable level which investors can easily research. Still, it is important to exercise caution, and some investors might want to take a different approach. After all, digging a little deeper we found that analysts have been cutting their earnings estimates for both banks. Analysts have reduced their estimate for EPS at Great Southern Bancorp, Inc. (NASDAQ:GSBC) from $2.38 two months ago to about $2.37 today. The average EPS estimate for Sierra Bancorp (NASDAQ:BSRR) has slipped from about $1.99 to $1.92.

Disclosure: At the time of publication, Erik Dellith did not directly own shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.