Owning a financial company remains a key part of maintaining a fully diversified portfolio. Among financials, the large U.S. regional banks are a compelling area to invest in. With sounder balance sheets, less exposure to Europe, and less regulatory overhang -- not to mention cleaner hands and reputations from the financial crisis -- regional banks have more flexibility and certainty than the multinationals. At the same time, when compared to small regional banks the large banks garner more attention and have stronger earnings power and earnings growth. None of this is to say that a bank like JPMorgan (NYSE:JPM) or Wells Fargo (NYSE:WFC) isn't worth considering (or a local bank with room to grow), but regional banks offer both safety and performance -- a little something of the best of both worlds.
Which bank is the best play on this sector? I screened for U.S.-based banks with a market cap between $10 and $50 billion. I then ran the numbers on their recent revenue growth, recent and predicted earnings growth, dividend yields, and relative ratios (including JPMorgan for a large bank bogey), and then put them in the following table:
As of Q1 2012
Quarterly Revenue Growth (Y-over-Y)
Yearly Revenue Growth
EPS Growth (Annual)
Estimated Earnings Growth (next 3 years)
Earnings 2012 (Est.)
Earnings 2013 (Est.)
Price Change (past 12 months, May 4th close)
Average Analyst Ratings (# of Analysts)
(Definitions: Revenue = (Non-interest Income + Interest Income), Yearly growth is 2011 vs. 2010, Quarterly Revenue Growth Year-Over-Year is Q1 2012 vs. Q1 2011; EPS growth measured across the past three to five years as applicable; Estimated earnings growth is based on average estimates from TDAmeritrade, WSJ; Book value/share is based on 2011 year-end share count; Average analyst ratings are based on WSJ research and ratings, averaged on a scale from 1 (Buy) to 5 (Sell).)
Source: TD Ameritrade and WSJ.
Here's a rundown of the contenders:
PNC Financial Services: The Pittsburgh-based bank is the largest of the banks on this list (except for JPMorgan). The bank passed the most recent Fed stress test and subsequently raised its dividend 14% to the current level. The stock also hit its 52-week high last Tuesday before pulling back 4% in the general market decline.
PNC Financial operates in 19 states and the District of Columbia. It recently acquired Royal Bank of Canada's (NYSE:RY) U.S. business, adding 400 banks in six southeastern states. During its most recent earnings conference call, CEO James Rohr politely pointed out that Royal Bank of Canada's services were way behind PNC Financial's offerings, meaning that PNC Financial has room to improve with these new banks and win new customers -- even if the integration becomes more expensive in the short term. PNC Financial also has an investment bank and a 25% stake in Blackrock.
PNC Financial's stock has slightly outperformed the general sector trajectory and is about $9-$10 in share price from its pre-2008 crisis highs. Compared to its peers, the stock is reasonably valued, suggesting that if the sector rises, PNC Financial could be a good vessel to catch the wave. At 11 times projected 2013 earnings, PNC Financial would hit $75.46, and at 1.25 times book value the stock would be worth $80.93. That range offers 15%-24% upside, plus the dividend.
Bank of New York Mellon: The New York bank has been a major underperformer in this group over the past year and since the crisis in general. The bank focuses on investment services and management, as such focusing on institutional clients. Trading revenue from foreign exchange markets is its third major source of revenue, though it ranks well below the other two in magnitude.
More of an investment bank and more directly tied to managing markets, Bank of New York Mellon has faced several headwinds that have knocked the stock down. There have been lawsuits thrown at the bank regarding its foreign exchange services, and it is now coming under scrutiny for exposure to the tri-party repo market, a market where it (and JPMorgan) serve as clearing banks and extend a great deal of credit on an intraday basis. On a fundamental basis, earnings haven't been great, with a surfeit of positive earnings surprises over the past couple of years.
While Bank of New York Mellon has underperformed, with shares still trading at about half of its pre-2008 levels, for a long-term investor there may be value opportunities here. Analysts forecast decent growth for the company's earnings in the next two years, and if it hits its marks, the bank could have more upside than its peers. If the shares traded at book value, the upside would be 18%, and at 11 times 2013 earnings that upside extends to about 20%. Of course, that possible upside is tempered by the headwinds.
M&T Bank: A commercial bank based in Buffalo, N.Y. (not Baltimore, despite what football fans might think), M&T Bank operates in eight states and Washington, D.C. The bank also acquired Wilmington Trust last year, adding an investment and wealth management arm to the bank. The bank has readjusted its balance sheet in an effort to help the integration of the new acquisition, the bank's largest since 2003 (when it acquired AllFirst Financial to enter the mid-Atlantic region, an acquisition that spurred the bank to acquire the naming rights of the Ravens football stadium).
M&T Bank has also underperformed the sector over the past year, though its performance has been steadier -- the stock didn't drop as greatly last summer/fall, and hasn't risen as steeply this winter/spring. Analysts rank this stock the lowest of the ones covered in this article. More concerning is that despite the stock's underperformance, it is among the most highly-valued in this cohort. The stock's growth has been solid and merits a decent multiple and M&T Bank pays the highest dividend in this group, but the stock seems to be at its near-term ceiling. This is one to avoid.
BB&T Corp.: Based in Winston-Salem, N.C., BB&T operates in 12 states -- mostly in the south, as well as Washington, D.C. The bank focuses on commercial, industrial, and retail loans, though it also has a sizable insurance business, one it has expanded through acquisitions over the past year of Liberty Benefit Insurance Services, Atlantic Risk Management Corp., and insurance divisions of the Crump Group.
BB&T has been the top performer in this group over the last year. It also raised its dividend after the March stress test. The question with BB&T is how much room to grow does it have left. While estimated to have one of the top growth rates in the sector in the years to come, its stock's value may already factor in the future growth sufficiently. Analysts are accordingly skeptical of continued growth, as BB&T scores the second worst average rating. Still, if an investor is convinced that BB&T can take advantage of its growing market and continue to meet targets, this might be a decent pickup on the pullback it may continue to face this month.
Fifth Third Bancorp: This commercial bank has locations in 12 states, mostly in the Midwest. While its business consists mostly safe, vanilla banking, its earnings got a boost from the IPO of Vantiv (NYSE:VNTV), a company that helps banks and companies process debit and credit card payments (Vantiv started as a unit of Fifth Third Bancorp).
The Cincinnati-based bank has outperformed the sector over the past year, though over the longer haul the stock still trades well below its pre-crisis (and pre-2003, specifically) levels. Fifth Third Bancorp raised its dividend last fall by 33%, and could easily raise the dividend again this fall as the payout ratio is quite low. The stock has been among the steadiest in the sector, and is still both lowly valued relative to peers and highly regarded as the top pick among the analysts of this group. Eleven times 2013 earnings puts the stock price at $16.83, 20% above current levels. With that and a possible dividend raise, Fifth Third Bancorp is a consistent performer with good prospects.
SunTrust Banks: If Fifth Third Bancorp is among the more dependable, duller plays in this group, SunTrust has more risk and possibly more reward. The Atlanta-based bank is another with broad southern exposure, and its business tilts more toward the commercial and investing services side of the spectrum. The bank went into negative earnings after the crisis and has struggled to grow them since then. It also suffered a recent headwind with the announcement that SunTrust failed the Fed stress test back in March, though interestingly the stock rose about 12% in the aftermath of the news.
The stress test was a near-miss for SunTrust. In the near term, it means the bank cannot raise its dividend to more meaningful levels. In the long-term, SunTrust's earnings are forecast to grow far faster than competitors'. The stock is, as such, overvalued based on last year's earnings, but undervalued based on future earnings and book value. Assuming the bank successfully resubmits its capital plan to the Fed, as many expect, a significant dividend hike could be in the offing. At 11 times 2013 earnings, the bank could hit $29.26, upside of 23.2%; if it traded at book value, SunTrust's share price would grow 58%. While the bank's slow past earnings and stress test failure are reasons for the heavy discount on future earnings, investors looking for a riskier bank play have an option here.
In the near term and midterm, PNC Financial and Fifth Third Bankcorp appear to be the best plays in this sector. SunTrust and Bank of New York Mellon are decent contrarian value-based plays, though I think SunTrust offers more upside for the risk than Bank of New York Mellon. M&T Bank appears to be overvalued without the growth to back it up, while BB&T Corp. has the growth and may be worth considering on a pullback. Whichever the vehicle, regional banks offer a reasonable yield and an opportunity to play the slow but continuing U.S. recovery without exposing oneself to ongoing European turmoil.
Disclosure: I am long PNC.