Regional Bank Bargains

 | Aug 22, 2011 | 4:00 PM EDT
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Apparently, the world ended over the past two weeks and I missed the memo. I was discussing regional banks over the weekend with some friends and the key question on everyone's mind was what happened in the past month to justify the sharp and seemingly endless selling? Some of these stocks got absolutely slaughtered over the past few weeks. Hudson City Bancorp (HCBK), one of my favorites, is down 31% on the past month and 10% for the last week alone. One friend pointed out that First Midwest Bancorp (FMBI) saw its price fall by 37% for the month and over 12% for the week. Many of the micro-cap banks I follow had similar results during the week.

A lot of reasons for the weakness have been tossed around, The economy remains very weak, and low interest rates and soft loan demand are pressuring interest income for many banks. At least on person blamed the Tea Party and the federal debt limit negotiations for increased regulatory pressure and lower fee income from new rules and laws enacted in the aftermath of the credit crisis. All of these are true, but they are all also well-known obstacles and do not explain the recent price bomb that went off in the sector. If the world did in fact end, or the yield curve is on the verge of permanently inverting, then the price decline makes a lot of sense. If not, then it appears there are some bargains in the sector.

I will start my look at banks with those located in the Midwestern part of the country. Value Line breaks these banks out into their own section, so it seemed a natural place to start looking at some of the regional banks. The Midwesterners are generally more conservative than their coastal counterparts in everything but their approach to baseball, so these banks tend to have fewer weird and toxic securities and loans on their books. The region is also seeing some benefits from a fairly healthy farm economy

I bought shares of Fifth Third Bancorp (FITB) for some clients back in the depths of the 2008 mess and sold when it appreciated into 2010. The stock fell by half and them better than doubled for me, so you should be aware that this type of price action is not out of the question this time. However, the bank is seeing loan losses abate and it is one of the few banks with loan loss reserves of more than twice the total loan loss provision. That's good old Midwestern prudence. The bank has more than 1,300 branches and a solid deposit base. It is first in market share of deposits in Ohio and second In Kentucky. It is in the top 10 of market share in Illinois, Michigan and Florida as well.

Fifth Third has a lot going for it. Non-performing loans are just 1.59% of total loans, well below most of its peer group right now. The bank did an equity raise back in January and has repaid its TARP funds. The dividend was increased sixfold and the stock now yields a respectable 2.6%. In the second half of the year, the bank could see the interest margins improve as higher rate CDs roll over to much lower interest rates.

The stock is becoming cheap once again. The shares currently trade at 90% of tangible book value. In the current market environment, I would like to start my scale buying on the regional banks at around 80% of tangible book value. Fortunately, my good friends in the options market are making it possible to create a long position at a little less than the $8 tangible book value of the Fifth Third. It looks like I can sell November $8 strike outs for $.50 or more to create a long position. If the stock is below $8 on expiration, I will own the stock at a net cost of $7.50. I am comfortable buying the stock at that level. If it is not, I will pocket the premium for an annualized gain of better than 25%.

The banks have pummeled in recent weeks. If the world is not ending, then there are some opportunities in this sector worth exploring. I will be looking deeper at banks this week to see what we can find.



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