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Southwestern banks and thrifts led the nation in showing signs of a turnaround based on key ratios related to profitability and asset quality. In contrast, financial institutions in the Southeast saw far less improvement, with banks in the region ranking at or near the bottom on both measures.We reviewed holdings of nonperforming loans as a percentage of total loans and return on average assets (ROAA) for more than 7,400 financial institutions to identify geographic areas where the health of the banking industry may be improving.

While nationwide, nonperforming loans as a percentage of total loans declined slightly year over year from 4.35% in third quarter 2010 to 4.30% in 2011, Southwestern banks saw a much more significant improvement, reporting the lowest nonperforming loan ratio in the nation of 2.65%, compared to 3.37% the year prior. Institutions including Prosperity Bank (PB), and Whitney Bank, a unit of Hancock Holding Company (HBHC), are headquartered in the Southwest and have loans portfolios with very few nonperformers.

Meanwhile, financial institutions in the Southeast, where E*Trade Bank, owned by E*Trade Financial (ETFC), RBC Bank (USA), a unit of Royal Bank of Canada (RY), and Synovus Bank (SNV) are headquartered, continued to be hampered with delinquent loans, posting a region-wide nonperforming loan ratio of 4.54%, the second worst after the Midwest aggregate of 4.86%.

The industry is beginning to see a turnaround, but with nonperforming loans still five times higher than pre-crisis levels, it's hardly out of the woods. A slightly improved economy, new banking regulations and reformed lending practices have contributed to the decrease in nonperforming loans. However, certain institutions in regions most impacted by the recession have been slower to recover and many remain at risk.

The industry's ROAA increased to 1.10% through third quarter 2011 from 0.72% during the same period in 2010. Again, banks in the Southwest, led by GE Capital Financial, a unit of General Electric (GE), and American Express Centurion Bank and American Express Federal Savings Bank, both units of American Express (AXP) enjoyed the highest ROAA, 1.61%, up from 1.21% a year ago. In contrast, Southeastern financial institutions reported the worst performance of the six regions with ROAA of only 0.76%, up from 0.58%. Results of the analysis on a state-by-state basis can be found here.

Clearly, bank industry investors have suffered losses in the past few years especially in the areas where real estate values dropped dramatically. Some investors even saw the value of their bank stock holdings fizzle to nothing as regulators shuttered institutions that were no longer viable. Investors that got burned along with those watching from the sidelines have found it difficult to jump into this sector even as stock prices have adjusted. There is mixed sentiment as to whether the industry can truly recover while U.S. and global economies continue to face challenges. But there are signs that at least some banks are turning the situation around, gaining profitability and taking the steps to eliminate high levels of nonperforming assets.

Banks operating in the southwestern region seem to be gaining strength as they increase profitability and find ways to improve the quality of the assets they hold. As the region recovers, these banks may be better positioned for growth and profit.

Prosperity Bancshares, Inc., the parent company of Prosperity Bank, a $9.8 billion Houston, Texas based regional holding company reported net income for the year ended December 31, 2011 of $141.749 million or $3.01 per diluted common share, up 11% and 10.3%, respectively. The closing price as of January 27 was $41.32. The bank increased loans and deposits by approximately 8% in 2011. In 2011, it also took steps to reduce commercial and construction loan holdings, which can be riskier, while maintaining its 1-4 family and commercial real estate loans. Prosperity was recognized by Forbes as the "Best Bank in America" in its 2012 rankings. This recognition was likely based on asset quality and strong earnings.

On January 19, Prosperity signed an agreement to acquire The Bank of Arlington's one banking office in the Dallas-Fort Worth area. This was its third acquisition in recent months, following the acquisition of East Texas Financial Services in Tyler and Texas Bankers Inc. in Austin. Prosperity's management seems to be working hard to build shareholder value.

Hancock Holding Company, the parent company of Hancock Bank and Whitney Bank, operates almost 300 branches across Mississippi, Louisiana, Alabama, Florida, and Texas. On January 26, the company announced fourth quarter 2011 net income of $19.0 million, or $.22 per diluted common share, compared to $17.0 million, or $.46, for fourth quarter 2010. Included in pre-tax earnings for the fourth quarter of 2011 were $40.2 million of merger-related costs. Merger costs in the fourth quarter of 2010 were immaterial.

In June 2011, Hancock acquired Whitney Holding Corporation headquartered in New Orleans, Louisiana. And in September, the Company completed the sale of eight Whitney Bank branches to resolve concentration concerns of the U.S. Department of Justice. As part of the divestiture, Hancock sold approximately $47 million in loans and approximately $180 million in deposits. On January 27, the stock price closed at $32.11. Institutions and mutual funds including Vanguard Group, Columbia Wanger Asset Management, State Street Corporation, and Perkins Investment Management own approximately 70% of the outstanding shares with Hancock's Bank Trust Department retaining ownership of about 5% of outstanding shares. While the company hasn't released a full comparison of 2011 to 2010 results, we think it's a good sign when insiders and institutional investors continue to have significant value invested.

American Express Company, the parent company for American Express Centurion Bank and American Express Federal Savings Bank reported 2011 net income from operations of $1.19 billion, a 12% increase from the prior year. AmEx reported seeing improved consumer credit quality and fewer loan defaults but also had to deal with loan portfolio losses. On January 27, 2012 shares closed at $49.85.

As the economy begins to strengthen, we expect overall bank industry financial health to improve. In that scenario, banks should be the beneficiaries of improved consumer creditworthiness and stronger savings and loan business. Many will have to continue to focus on addressing issues related to nonperforming assets until they reach more reasonable levels. They'll have to find ways to increase top-line revenue while continuing to control expenses and implement operating efficiencies to offset revenue reductions resulting from the implementation of legislative fee restrictions and other consumer protections.

The industry will continue to face a challenging environment as government regulators introduce more stringent controls for capital levels, exams, reporting, and reduced interdependency between institutions. As this industry has always found ways to make significant profit through product innovation and marketing, we expect there will be opportunity for investors to identify strong and improving performers.

For example, even in this low interest rate environment, the industry continues to benefit from stock market volatility as investors have moved to the safety of bank-sponsored, fixed return instruments. With more and more baby boomers reaching retirement age and needing to safeguard assets, we expect banks will be able to hold onto those deposits especially if interest rates begin to rise.

This is a sector that is worth watching for investment opportunities as the U.S. emerges from recessionary conditions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Southwestern Banks Lead Turnaround; Southeastern Banks Still Struggle