The banking industry has been under close scrutiny since the recession. Many large banks have been facing stiffer regulations, tougher economic conditions and increasingly negative investor sentiment. In this article, I will hone in on two stellar banks that are strategically positioned to perform well in the coming years, unlike many of their peers. Here are the highlights of my research:
Regions Financial (RF) is one of the mid South's leading bank holding companies, with over 1,700 branches scattered across the Gulf coastal and southern Atlantic coastal states. As such, it was slammed, perhaps worse than any other large bank, by mortgage losses in the last recession. It was the last of the nation's 20 largest banks to repay its TARP loans, and its earnings and stock price are still a small fraction of what they were prior to the banking recession. For a time, I wondered if this bank was even going to survive. I now expect it not just to survive, but actually to grow and thrive.
The first half of 2012 for Regions has been about putting the past behind it. As its balance sheet stammered in 2007 and 2008, it accepted $3.5 billion in TARP loans. As time went on, and a profit recovery was nowhere in sight, it took fairly drastic action to raise the funds to pay back the loan. It sold its Morgan Keegan retail brokerage to Raymond James (RJF) for $900 million in April of this year, and in March of this year, the bank sold 153 million shares of stock for just under $6 per share, raising an additional $900 million. Taking these assets and adding to them some retained earnings, and on April 4, 2012, Regions paid back its debt to the Treasury in full.
After all of these necessary moves, one might think that what is left of Regions is a large regional bank without frills. That would be wrong. So spooked, apparently, is management of loan losses that the bank is working to become more of a fee-based institution. In 2004, the bank formed an insurance arm, which now sells full lines of commercial and personal insurance through a network of thirty offices spread across eight states. Further growth in the insurance arm is expected, and will in the future act as a buffer to both good times and bad with the core banking business.
That core banking business has become marginally profitable of late, but largely on the back of reduced loan loss provisions, as opposed to any sort of growth. The bank's net interest margin has been quite stable over the past six quarters, ranging between 3.0% and 3.1%. In the first quarter it was 3.04%, definitely on the low side for a regional bank. Regional peer bank holding company BB&T (BBT) net interest margin in the first quarter was 3.93%, and SunTrust's first quarter margin was 3.49%. What is disappointing is that Region's net interest margin is so far lower than its regional peers, despite falling credit costs. Interest expense fell by $65 million from the first quarter of 2011 to $170 million, a 28% drop. But interest income also fell by $93 million. Regions' loan portfolio has been in decline for several years, declining from over $97 billion in 2008 to $74 billion as of March 31, 2012. It will only be when the bank increases its loan portfolio that it will reverse its slide in interest income.
Regions does not have, in my opinion, as favored a geographic footprint as either SunTrust of BB&T. However, it has one thing that those banks don't; Texas. Regions is making a point of focusing on Texas going forward, and if done effectively, can be the source of a virtually unlimited amount of loan business, something Comerica Bank (CMA), knew when it moved its headquarters from Detroit to Dallas in 2007.
On the strength of Regions increased capitalization and preferred stock retirement, S&P raised the bank's debt rating to BBB1/A3. Earnings are expected to more than triple this year, from $0.17 in 2011 to $0.61 this year. The second quarter earnings report will be a key indicator, and will be released the third week of July. I am looking for earnings of at least $0.16 per share. Much of the earnings gains will continue to be based on favorable loan loss provisions comparisons. Regions set aside over $1.5 billion for bad loans last year, a high amount in 2011 for a bank Regions' size.
There are rumors that Regions would make a fine acquisition by a larger bank. Yet on its own, Regions holds substantial speculative appeal. If by 2014, long term interest rates begin to rise, and Regions begins expanding its loan portfolio, this bank should be able to earn profits of over $1.5 billion, or $1.20 per share, by mid-decade.
Wells Fargo (WFC) is among Regions competitors in some of its major markets, such as Florida. If the universe were Regions' geographic footprint, it would be the second largest bank by deposit market share, behind only Bank of America (BAC). Regions has a 9.8% market share within the region, and Wells Fargo is the third largest, with a 9.4% market share. By most any measure, Regions would do well to aspire to become as financially fit and as profitable as Wells Fargo, but customers do not necessarily care about that. Customers actually give Regions a higher satisfaction score than they give to Wells Fargo.
Perhaps the most important lesson any bank, large or small, can learn from Wells Fargo's experience is that as long as there is effective underwriting, there is no excuse not to try to grow a loan portfolio. Of late, Wells Fargo has been originating about one third of the country's new mortgage loans. Under the bank's cross selling program, a majority of those mortgage customers will have Wells Fargo checking accounts and credit cards. Since it is already the nation's most profitable large bank, I fully expect Wells Fargo to continue to grow its annual earnings at an impressive 12% to 15% clip going forward. There is no better growth stock in the banking sector than Wells Fargo.