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.
Recovery in real estate
During the meltdown of the mortgage industry, Florida was one of the most severely damaged real estate markets in the nation. A lot of banks and mortgage lenders in that area went bankrupt; one that didn’t was BankUnited (NYSE:BKU). I had a friend who was fond of saying that anything that doesn’t kill you makes you stronger. That seems to be the case with BankUnited (NYSE:BKU). The shares currently pay a very attractive yield of 3.33%, requiring a payout ratio of only 38%. This relatively low payout should make the dividend very safe. In addition, the five-year projected growth rate of 7.2%, coupled with the dividend payout, should be able to produce annual returns just over 10% per year.
Florida real estate prices seem to have bottomed out last year and are in a solid upswing at this time. This makes asset-secured lending in Florida very safe, as it is based on depressed appraisal values and made against rapidly appreciating assets.
Profitable conclusions and actions
An objective assessment of risk/reward potential would seem to rank International Bancshares Corp (NASDAQ:IBOC) the safest of the three with the most upside potential, given the prospects for a rise in the price to book ratio and the economic activity being driven by the oil and gas boom underway within the region. This stock is screaming to be purchased at the current level.
Hancock Holding Company (NASDAQ:HBHC) is priced in line with International, but in a region with slightly less secure prospects for economic growth. This assessment places it solidly in second place in regard to the risk/reward calculation.
BankUnited (NYSE:BKU) carries the highest current valuation of the three, and, in my opinion, has the least upside potential. This is not meant to imply that it would not make a good investment. I just don’t see it as the best option available in the sector at this time.
The article Buy Small Banks For Big Profits originally appeared on Fool.com and is written by Ken McGaha.
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