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A diversified portfolio remains the best way to limit the gambling nature of investing. By spreading the risk around, an investor may be limiting the high end of his/her possible gain, but s/he is also limiting the downside of everything going bad. The diversity can be spread across different market capitalization sizes, between growth and value stocks or dividend payers and speculative high-flyers, and among the different sectors of the market.

Such is the argument for sticking with financial stocks despite the lumps the cohort has endured over the past few years: diversity, dividends, and capturing a big part of the market (financials constitute 14.7% of the S&P 500, the second largest sector after info tech).

There are better ways and worse ways to play the sector. In the current regulatory and economic environment, playing the oversized banks like JP Morgan (JPM) or Bank of America (BAC), or an investment bank like Morgan Stanley (MS) or Goldman Sachs (GS) is too risky and too prone to widely-covered bad news, whether the failure to get approval for a dividend hike, the unexpected loss of $2B on a trade, or the botched delivery of the biggest IPO ever.

Instead, there is a growing consensus among investors and analysts that regional banks and smaller banking institutions are safer, more promising financial plays. Banks whose business is more traditional, wholly domestic, and tied mainly to the slow but sure recovery of the American economy and the housing industry seem more reasonable plays. True, the worrying trend in jobs growth over the past two months has dented this reasoning a bit, but we are still in a recovery environment, and the U.S. will return to form eventually. Whenever it does, these local and regional bank stocks will soar; until then, these banks pay quality dividends that make waiting tolerable.

In two other articles, I looked at a set of large regional banks and a group of smaller banks or savings & loans institutions, respectively, to find some worthwhile investments. In my two portfolios I have one stock from the former group and one from the latter group, and I feel pretty comfortable about staying in those investment groupings.

This article addresses the middle ground between those two groups, smaller regional banks. I ran a screen for regional banks with a market cap of $2-6B that have at least a 2.5% dividend yield. I then ran numbers on revenue, earnings, book value, and valuation metrics, resulting in the following table:

(Sources: TDAmeritrade, WSJ, Jayhawk Consensus)

As of Q1 2012, June 6th price close

Bank Of Hawaii (BOH)

Valley National Bancorp (VLY)

Hancock Holding Company (HBHC)

First Niagara Financial Group (FNFG)

Cullen/Frost Bankers (CFR)

BOK Financial (BOKF)

Huntington National Bank (HBAN)

Market Cap

$2B

$2.2B

$2.4B

$2.7B

$3.4B

$3.7B

$5.3B

Quarterly Revenue Growth (Y-over-Y)

-5.40%

-8.80%

118%

35%

1.30%

76.48%

3.75%

Yearly Revenue Growth

-12.8%

4.30%

63.23%

40.41%

1.56%

0

-7.60%

EPS Growth (Annual)

flat

-3.30%

1.60%

14.64%

0.74%

9.60%

NA

Estimated Earnings Growth (next 3 years)

6.34%

6.52%

11.34%

5.82%

6.96%

5.31%

8.86%

Earnings 2011

3.39

0.75

2.02

0.98

3.58

4.17

0.59

Earnings 2012 (Est.)

3.53

0.73

2.35

0.88

3.82

4.55

0.64

Earnings 2013 (Est.)

3.56

0.78

2.74

1.02

3.89

4.54

0.67

Book Value/Share

21.24

7.1

35.83

16.35

37.44

40.44

5.78

2011 P/E

13.21

14.56

14.06

8.14

15.32

13

10.34

2012 P/E

12.69

14.96

12.09

9.07

14.36

11.91

9.53

2013 P/E

12.58

14

10.37

7.82

14.10

11.94

9.10

P/Book

2.11

1.54

0.79

0.49

1.47

1.34

1.06

Price

44.79

10.92

28.41

7.98

54.86

54.19

6.1

Dividend

(Yield %)

1.8 (4.02%)

.65 (5.95%)

.96 (3.38%)

.32 (4.01%)

1.92 (3.5%)

1.52 (2.8%)

.16 (2.62%)

Price Change (past 12 months

-1.71%

-16.27%

-9.69%

-42.44%

-0.36%

4.76%

0.66%

Av. Analyst Ratings (# of Analysts)

2.79 (19)

3.39

(18)

3.22

(18)

2.38

(16)

2.89

(19)

2.65

(17)

2.79

(19)

(Definitions: Revenue = (Non-interest Income + Interest Income), Yearly growth is 2011 v. 2010, Quarterly Revenue Growth Y-over-Y is Q1 2012 v. Q1 2011; EPS growth measured across past 3-5 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 Jayhawk Consensus figures, averaged on a scale from 1 (Buy) to 5 (Sell))

A look at the banks in question:

Bank of Hawaii - The Bank of Hawaii is, unsurprisingly, based in Hawaii. The bank has 79 branches on the Hawaiian islands and in Guam, Saipan, Palau, and American Samoa. The bank focuses its business on Treasury services (responsible for 42% of Q1 2012 net income), commercial services (39%), and retail services (15%), with a small investment component as well. The bank's position was strong enough that it could decline to participate in the TARP program in 2008, and it has been able to maintain its dividend throughout the post-crisis period; at the same time, BOH has not raised the dividend since the crisis after doing so on a yearly basis for a decade prior.

The bank's revenue growth and earnings growth has not been particularly strong, and the forecasted growth is not much more promising. As the chart below shows, the bank's payout ratio remains much higher than the pre-2008 era, suggesting that a return to dividend hikes is not imminent. As that implies, earnings have not returned to a pre-crisis level either. The valuations are relatively high for BOH compared to the rest of this group, however; only Valley Bancorp and Cullen/Frost Bankers Inc. have consistently higher P/E ratios, and Bank of Hawaii's book value is much lower than the stock price.

BOH Chart
(Click to enlarge)

BOH data by YCharts

(Note: Earnings per share are on a quarterly basis)

Bank of Hawaii has done very well to maintain positive earnings through a trying period, and Hawaii is in a more stable economic position than much of the country (BOH reported on its earnings report that Hawaii's unemployment rate as of the end of March was 6.4% compared to 8.2% nationally), but considering the growth prospects and the valuation, there seem to be better options in this group.

Valley National Bancorp - Valley National Bancorp is based in New Jersey and has 211 branches across the top half of the Armpit State and in New York City. The regional positioning is a strong one, as New York City especially and the Northeast in general tend to have good growth metrics, if not necessarily the strong demographics of the south. Valley recently acquired State Bancorp, a small, Long Island-based bank with 17 branches, further entrenching Valley in the NY/NJ region. The bank's main businesses are Commercial Lending, Consumer Lending, Wealth Management, and Insurance Services.

Valley is interesting as a stock for two reasons. First, despite a year of negative price movement and cautious analyst sentiment, the stock is highly valued compared to peers. The second interesting thing may explain the first: the company's dividend policy. The bank has paid a 5% stock dividend to shareholders for ten years in a row (the most recent payout coming in May 2012), a dilutive effect that might explain some of its lower earnings growth numbers. The company also pays almost all its earnings out in dividends: the payout ratio based on the first quarter dividend and earnings estimates for 2012 would be 89%. Additionally, the dividend has not been very consistent since the crisis; after staying steady at $.658/share for the year through the crisis, the dividend dropped twice in consecutive years, came back up to $.6572/share last year, and has been dropped again for the first quarter of this year to an annualized $.65/share. The company has been very clear that past dividend figures, "should not be used as an indicator of future dividends to Valley's stockholders."

So on the one hand, Valley pays the best dividend in the group along with a nice yearly stock dividend bonus. On the other hand, the payout ratio is quite high, suggesting there's not much room for it to grow without earnings growth, which is not expected to be great. The valuation is also high. Valley pays a nice dividend, but there are safer high dividend yields out there, and it might be better to buy stock in a smaller bank in Valley's area that the company might acquire instead.

Hancock Holding Company - Hancock Holding Company is a Gulfport, MS based company, the parent institution of "Hancock Bank and Whitney Bank and operates 258 branches and more than 350 ATMs across Mississippi, Louisiana, Alabama, Florida, and Texas," as well as of an investment services branch, two insurance agencies, and several corporate trust offices. The company is the result of a merger between Hancock and Whitney; the latter is based in New Orleans and offers the branches in Texas and Louisiana, possibly more attractive markets than the other three states due to Texas's growth and Louisiania's rebuilding in the post-Hurricane Katrina era.

The company has promising growth forecast for it, though we can discount the amazing revenue growth numbers as largely related to the merger. Regardless, the analysts' estimates lead to an expected growth rate well above its peers. If the company can hit those growth numbers, a dividend hike could also be in the cards; the company has held steady at a $.96/share annual dividend rate since 2006, which would be a 41% payout ratio at 2012's estimated earnings, and a mere 35% at 2013's estimates.

Analyst sentiment suggests concerns over integrating Whitney and Hancock's growth position. That said, once the company finishes paying the acquisition costs and moves forward as a united entity, earnings, dividend, and stock price could all go a good deal higher. This is an interesting play.

First Niagara Financial Group - First Niagara has a similar profile to Hancock with two major differences: it is based in the Northeast, not the Gulf, and it has long been an analyst's darling, and is the top-rated bank in this cohort. The Buffalo-based bank has nearly 430 branches in upstate New York, Pennsylvania, Connecticut, and Massachusetts. The bank has been an acquirer, first merging with Connecticut-based New Alliance Bankshares (closing on the deal in mid-2011) and then picking up HSBC's banks in upstate New York and southern Connecticut in a move the company described as an "acceleration of its growth strategy."

With that acceleration has come some costly fuel. Integration costs are expected to eat into 2012 earnings, which are forecast to drop from 2011 levels; the company's Q1 2012 earnings presentation cites these costs as the exact reason earnings dropped compared to Q4 2011. Additionally, the dividend has been burned; after being one of the few banks to raise dividends twice since 2008, FNFG has cut its dividend by 50% this year in an effort to build capital levels and in reflection of a common stock offering that helped fund the recent acquisitions.

An additional stock offering and a dividend cut never bode well for a stock price, and FNFG has been unsurprisingly hammered, losing more than 40% of its share value over the past year. That provides an opportunity to get into the stock cheap, however, and the stock price has dropped enough that the dividend yield is back at its historic levels of about 4%.

FNFG Chart
(Click to enlarge)

FNFG data by YCharts

If one believes that FNFG will successfully manage the post-merger period, a return to earnings growth could see FNFG earn a much higher, more reasonable multiple. At a Price/Book ratio of 1, the stock would nearly double, and at 10x 2013 earnings, the stock would be worth 66% more. Like Hancock, the merger discount adds risk now but the possibility of great reward if First Niagara gets it right. Analysts seem pretty confident that they will.

Cullen/Frost Bankers Inc - Cullen/Frost messes with nothing but Texas. The San Antonio-based bank operates solely in the Lone Star State, which is a good geographic region to be in. The stock represents more of a hybrid, as the institution features a stronger investment/financial component than the other companies discussed here.

Still, Cullen/Frost is a bank, and a high-performing one at that. The company has churned out solid earnings in these difficult times, and 2011's earnings marked a return to pre-crisis levels. Cullen/Frost also just announced a 4.35% dividend hike, meaning it has already been able to translate increased earnings into more cash for its shareholders. The company has managed to raise the dividend annually since the crisis, a very impressive fact considering the environment and its peers, and one that earns the company dividend contender status.

That said, the valuation is quite high on all accounts, and the dividend yield is below some of its peers. Those who like a steady story of growth, stock price appreciation over the long haul, and dividend growth would do well to consider this rose from Texas. Those looking for a bigger value play might head elsewhere, however. For example …

BOK Financial Corporation - Sticking with the southwest, we turn to Tulsa, Oklahoma-based BOK Financial. The holding company runs seven banks: Bank of Albuquerque, Bank of Arizona, Bank of Arkansas, Bank of Kansas City, Bank of Oklahoma, Bank of Texas, and Colorado State Bank and Trust. The Sun Belt is a strong area of growth, which makes the bank behind it fairly attractive. Beyond commercial and consumer banking through these outlets, BOK Financial has a notable wealth management business.

BOK Financial shares more than geographic area in common with Cullen/Frost. The bank has raised its dividend twice in the past year and every year since the crisis. While the dividend yield is a good bit lower at under 3%, BOK Financial's payout ratio is also much lower. On top of that, the valuation is much more promising for BOK Financial than its Texan neighbor.

CFR Dividend Chart
(Click to enlarge)

CFR Dividend data by YCharts

(Note: Earnings per share are on a quarterly basis)

BOK Financial is expected to have choppy growth over the next couple of years before picking up in 2014. That said, it is in a strong region of the country, and has not made an acquisition for five years, suggesting two things: first, no headwinds in the near-term from integration costs, which could give it room to grow if the region continues on its strong trajectory, and second, that BOK Financial could expand if it so desires, which might inject more growth into the equation (yes, those points are somewhat contradictory. Consider it a heads you win, tails you win situation then).

Those who like the Sun Belt, dividend growth, and steady earnings would do well to consider BOK Financial, and in the head to head with Cullen/Frost, it seems to be the better play.

Huntington National Bank - The last bank in our list is also the biggest, and the best known. Huntington is based on Columbus, Ohio, with over 660 branches in Ohio, Michigan, West Virginia, Pennsylvania, Indiana, and Kentucky.

In a way, Huntington doesn't belong on this list. The bank is much bigger than the others listed, and its profile fits more with larger regional banks like Key Corp (KEY) and M&T Regional (MTB), for example. The earnings turned negative in the crisis aftermath, and the dividend was cut in a huge way over that period, only just barely picking up steam again. The bank is also subject to more direct federal regulation, for example having to submit a capital plan to the Federal Reserve earlier this year for approval over its dividend and general capital plan.

That said, it provides an instructive comparison for what some of these other banks might become. Huntington's valuation is lower than all but one of the banks on this list (First Niagara), and the company is a bit of a battleground for analysts. The company's growth has been choppy, and while its outlook for earnings is positive, Huntington has also telegraphed its intention to keep the dividend the same through Q1 2013.

Huntington, more than the other banks on this list, seems levered to the national recovery. Based in the Midwest, a region more prone to cyclical issues and one that has struggled more than the Northeast or the South, Huntington needs positive employment growth and an overall positive picture in the U.S. Those who believe that we will see that return to growth over the coming two years might want to invest in Huntington. Those who are more skeptical could turn elsewhere.

Summary

Based on growth, valuation, dividend levels, and geographic positioning, I like First Niagara most out of this group, as the discount related to the merger creates a strong buying opportunity. Hancock is similarly attractive, with a little less upside but a more consistent track record and stock performance. Bank of Hawaii and Valley do not seem worth the investment despite the former's steady performance and both companies' quality dividend yield. BOK Financial is attractive as a play on the Southwest, though its dividend isn't as high as Cullen/Frost, a more expensive pick. Lastly, Huntington looms as the ultimate bull play in this group, a stock to invest in if you want to be levered directly to mid or long-term U.S. growth.

Diversity in investing is attractive, and regional banks remain safer and more appealing to me than the multinational banks. If I had to pick one bank out of this group, I would pick First Niagara. I hope you might find one of these banks an interesting investment if you have a hole in the financial portion of your portfolio, in both senses of the word.

Source: Winners Among Smaller Regional Banks: First Niagara, Hancock, Even Huntington?