By Carla Pasternak
Banks are among the most hated institutions in the world, seen by many as the epitome of corporate greed. Investors have no love to spare for banks, either. Financials were the worst-performing sector in the S&P 500 in 2011, with losses of more than 20%, compared with about 2% for the overall market.
But the sector is diverse, from big money centers such as Bank of America (NYSE: BAC) to smaller regional banks such as Huntington Bancshares (Nasdaq: HBAN). There's a big difference between these two groups, and it's not just in their size.
While both groups are federally chartered, they operate under different legislation. As a result, most regional banks focus on the traditional banking activities of savings deposits and mortgages and other loans.
They devote little, if any, resources to securitizing mortgage loans or hedging with derivatives, as the big banks do. Most regional banks also aren't exposed to risky euro-zone debt or faced with the massive mortgage lawsuits of their bigger brethren.
With little exposure to subprime mortgages, regional banks largely dodged the debt crisis of 2008. These banks, as represented by the SPDR S&P Regional Banking ETF (NYSE: KRE), lost 18% in 2008. In contrast, their big-cap brethren, represented by the SPDR S&P Bank ETF (NYSE: KBE), swooned with a loss of more than 47%.
Regional banks didn't fare as well as their large-cap counterparts in 2009, however, amid concerns that the weak real estate market would affect their residential and commercial real-estate loans. As of March 2010, 54% of the assets of smaller banks were related to real estate, compared with 43% of the 25 largest U.S. banks, according to Bruce Tuckman, author of Fixed Income Securities.
But now they are back on the radar screen and starting to attract investor attention. Regional banks gained close to 15% in the past three months, compared with less than 5% for large-cap bank stocks.
What's driving their recent outperformance? With fewer issues on their plate than the larger money centers, regional banks are benefitting from stronger industry fundamentals. While revenue is being pressured by near record-low interest rates on their loans, loan volume is picking up. U.S. Federal Reserve data for the third quarter of this 2011 showed that business loans rose 2.4% from the second quarter to just over $1 trillion. Consumer credit-card loans also rose slightly (0.7%) from the second quarter.
Credit quality is also improving. Careful credit checks are resulting in fewer delinquent loans, and banks don't need to set aside as much money to cover bad loans, so costs are lower and earnings are higher.
Consider Huntington Bancshares, one of the nation's largest regional banks. A 5.3% increase in consumer loans in the third quarter helped increase total loans and leases by 4%. The quality of the loan book also improved, as problem loans were just 0.92% of average loans, down from 1.98% a year-ago. As a result, loan-loss provisions dropped from $119 million to $44 million, and net income rose 42%.
After a bit of digging, I found five market-beating regional bank stocks with yields of around 5%.
Here they are...
These stocks offer a rich yield, even after delivering double-digit returns during the past year. Moreover, with dividend payout ratios of 80% of earnings or less, these companies can afford to keep paying high yields. All of them kept their dividend intact, without skipping a beat, during the financial crisis of 2008.
Fundamentally, the companies look healthy. All are consistently profitable and maintain a loan-to-deposit ratio of 100% or less, allowing them to internally generate the funds needed for loan growth. Priced at less than 17 times earnings and less than 2.5 times their tangible book value (which excludes goodwill), the shares offer good value, and some offer exceptional value at today's prices.
Risks to Consider: Remember, these ideas are merely a good starting point for further research. Some of these securities may make better investments than others. You should evaluate the fundamental characteristics of each stock in this table and assess how well it matches your portfolio needs.
All of these stocks look worthy of further analysis, but Commercial National Financial (Nasdaq: CNAF) sports some of the most impressive metrics. It has delivered the best annual total returns of the group and still enjoys yield near 5%.
It's also the fastest dividend grower in the group with a five-year average rate of 3.3%. Its annual dividend payout ratio of just 46% of earnings is the lowest in the group, leaving room for more growth. In fact, the latest quarterly dividend was hiked a whopping 18% over the previous quarter's payout.
Disclosure: Neither Carla Pasternak nor StreetAuthority, LLC hold positions in any securities mentioned in this article.