It speaks volumes about the state of the financial markets when not being “too big to fail” is a selling point, but that is the case for regional and community banks. Unlike their plus-size brethren, many of which gained notoriety during the 2008-09 financial meltdown, smaller banks tend to be unencumbered by questionable assets or complicated product lines. That has allowed them to operate, if not thrive, just below regulators' radar.
“Most regional banks have cleaner business models because they don't have a lot of messy legacy assets,” said Erik Oja, a banking analyst at Capital IQ, a unit of Standard & Poor's Financial Services LLC. “They're also not positioned squarely in the regulatory spotlight.”
Specifically, Mr. Oja was referring to increased lending scrutiny from the Consumer Financial Protection Bureau and new rules related to proprietary trading and market-making practices. They are mandated under the pending “Volcker rule” — part of the Dodd-Frank reform law — that is designed to keep consumer lending operations inside financial institutions separate from investment banking and proprietary trading operations.
Of the five largest regional banks, he is most bullish on Fifth Third Bancorp (FITB), PNC Financial Services Group Inc. (PNC) and Regions Financial Corp. (RF).
Mr. Oja is less bullish on but maintains a positive outlook for BB&T Corp. (BBT) and Sun Trust Banks Inc. (STI).
An exchange-traded-fund proxy for regional-bank stocks, SPDR S&P Regional Banking ETF (KRE), declined by 5.9% last year. But the story is really the recovery in the fourth quarter, which saw the ETF gain 27.2%.
Another ETF, iShares Dow Jones U.S. Regional Banks (IAT), finished last year down 12.7% but rallied 17.7% from the end of September.
The S&P 500 gained 2% last year, including an 11% gain from the end of September.
In the open-end-mutual-fund arena, two of the funds with the most exposure to the large regionals are John Hancock Regional Bank Fund (FRBFX) and Fidelity Select Banking (FSRBX).
The Hancock fund declined by 17.9% last year but gained 8.9% from the end of September. Meanwhile, the Fidelity fund declined by 13.7% last year but gained 16.9% from the end of September.
Last year, bank valuations in general were held down by a “trifecta of bad news, including the Japanese tsunami and nuclear disaster; the U.S. economic slowdown, with total federal gridlock and accompanying sovereign-debt downgrade; and the seemingly never-ending European debt and banking crisis,” Mr. Oja said.
Even though many of the risks associated with the European economy remain unresolved and the U.S. economy is still sluggish at best, there is support for smaller banks at this point in the market cycle.
Andrew Boord, senior research analyst at Fenimore Asset Management Inc., doesn't think that smaller banks were totally innocent bystanders during the period leading up to the financial crisis, but he does recognize the limits of potential risk.
“Some of the regionals deserve a lot of the pain for the way they were lending money to homebuilders and land developers,” he said. “But most [smaller-bank executives] couldn't even find Greece on a map, and there are a lot of those banks that didn't do stupid things.”
Mr. Boord, whose firm has $1.6 billion under management, prefers the smaller end of the banking continuum, including standouts such as Bank of the Ozarks Inc. (OZRK) and Home BancShares Inc. (HOMB).
FEW FAILED LOANS
“These are the kind of companies that didn't have a lot of failed loans, and they also were able to buy up failed banks from the FDIC,” he said.
Although some have raised concerns about how well these smaller community-type banks will be able to handle the rigors of increased regulatory oversight, the market so far has shrugged off such concerns.
Bank of the Ozarks, which saw its stock price dip during the late summer along with the rest of the market, gained 39% last year, and on Jan. 12, the stock reached a high of more than $31.
Home BancShares gained 19% last year.
“The real estate bubble was so pronounced, and it left so many banks in a stressed state, that now we're seeing the banks with a lot of capital and experienced management teams succeed,” said Tim Holland, portfolio manager at Tamro Capital Partners LLC, which has $1.6 billion under management.
The strong stock performance of some of the banks has pushed some of the valuations higher.
But as Mr. Holland pointed out, there are nearly 900 banks on the Federal Deposit Insurance Corp.'s at-risk watch list, which means more consolidation ahead.
“Down the market cap structure, there are a lot of smaller banks that did things like held on to the mortgages that they originated,” he said. “Those kinds of banks are now in a position to get organic growth and loan growth on attractive terms.”
Questions, observations, stock tips? E-mail Jeff Benjamin at jbenjamin@investmentnews.com
