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International Bancshares Corp (IBOC), Hancock Holding Company (HBHC), BankUnited (BKU): Buy Small Banks For Big Profits

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International Bancshares Corp (NASDAQ:IBOC)We constantly hear talk in the financial news about the “banking sector” and are inundated with names like Citigroup Inc (NYSE:C), Bank of America Corp (NYSE:BAC), and Wells Fargo & Co (NYSE:WFC). What many investors never take the time to consider or analyze is the segment of the banking business we never hear about on the news, even though it offers exceptional opportunities for gains – small regional banks.

Advantages of regional banks

Regional banks have a much smaller geographic area within which they operate, and also tend to have more direct contact with the customers to whom they are making loans. Given the more personal and intimate knowledge regarding the region in which they operate, it is quite reasonable to expect a lower loan default rate than what is seen in loan portfolios of larger banks. This regional approach also allows potential investors to select banks located in areas that are more prosperous than the country as a whole. In today’s mixed economic environment, that is an exceptional advantage. A strong local economy tends to lower the loan default rate, thus increasing profitability and growth.

In the United States today, the economic conditions of different regions within the country are almost as varied as if they were different countries. While the mid-west, far west, and northeast continue to be mired in slow to declining economic growth and very high unemployment, the southeast and southwest areas seem to be rebounding nicely. While the banking industry average price to book ratio is 1.5, we can find banks doing business in regions with strong underlying economies that are trading at multiples below the industry average. These are the businesses we should look to in order to achieve outstanding returns on our investment dollars.

Opportunities in the shale boom region

In Texas and Oklahoma, a resurgent oil and gas industry is creating massive numbers of high-paying jobs and extremely low unemployment. There is an increasing demand for housing and business services required to meet the needs of a burgeoning population. The loans made in these areas become very safe as the rapidly growing local economies produce wealth at a very quick pace.

International Bancshares Corp (NASDAQ:IBOC) operates 215 facilities throughout south, central, and southeast Texas and Oklahoma, and is one of the beneficiaries of the economic juggernaut created by the oil and gas shale industry. It currently trades at only 92% of book value, which would allow for a 50% appreciation in the share price just to trade at the industry average.

The current dividend yield on the stock is only 2.04%, but the payout ratio is a very conservative 29%, leaving a great deal of room for increases in the dividend. Sporting a five-year projected earnings growth rate for the next five years of 10%, and a P/E of 12.49 times 2014 consensus earnings projections, this stock offers the realistic prospect of returning a total of 10%-12% per year to investors for at least the next five years, if not longer. Those returns would be in addition to any increase in the price to book valuation.

Growth driven by storm damage and petrochemical development

The Gulf Coast area of the southeastern U.S. has been battered over the last several years by severe storms and a catastrophic oil spill. However, environmental and weather-related disasters also create the opportunity to profit from economic activity involved in repair and rebuilding efforts. In addition, lower natural gas prices are creating an industrial boom in this region, driven by a huge upswing in the plastic and petrochemical industries, which are heavily dependent upon natural gas supplies for their production operation. Lower gas prices mean lower operating and production costs.

Hancock Holding Company (NASDAQ:HBHC) operates about 300 banking locations in the coastal region around the Gulf of Mexico and is well-positioned to prosper from this economic activity. As with International Bancshares Corp (NASDAQ:IBOC), the price to book ratio, at only 94%, could appreciate by 50% and still have this bank priced in line with the industry average. Given the 3.49% dividend yield and the five-year projected earnings growth rate of 8%, this is an investment that should return 11%-12% per year going forward. Any capital gains realized from an increase in the price to book ratio would simply be icing on the cake.

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