Regional Bank Round-Up

It seems that banks got us into this mess, but are they finally getting themselves out? If you look at the performance of the stocks, at least as measured by the SPDR KBW Regional Banking ETF (NYSE:KRE), it is tempting to say "yes". After all, regional banks have done well so far this year relative to the S&P 500; up about 25% versus a roughly 7% gain in the broader market index.

IN PICTURES: 20 Tools For Building Up Your Portfolio

If only it were that simple. We have all seen that the market is a measure of what people think is going to happen, and not necessarily an accurate measure of what is happening on the ground. Luckily for all us, a recent batch of big regional bank earnings does suggest that business is looking up.

Overall Downturn
USBancorp (NYSE:USB) is maybe the best example of how a company can be exceptionally well-run and conservative and still get dragged down by the mistakes of its competitors. Even so, it is not hard to see signs of recovery here.

Revenue was down a bit in the first quarter, but deposits grew nicely (4.5%), the net interest margin stayed pretty strong (3.9%) and the loan portfolio grew (3.9%). Credit quality was something of a mixed bag. The company has maintained the same level of provisioning over the past year, but charge-offs have risen steadily and are within 15% of provisions. If the economy has stabilized, that should be fine (as the company has perhaps built up a surplus of reserves), but another rash of defaults would likely stimulate more provisioning and lower earnings.

Harder Hit
Zions Bancorp (Nasdaq:ZION) stands in rather sharp contrast to USB. Zions was both more aggressive than USB and more concentrated (80% of its deposits were in Utah, California, Texas, Arizona and Nevada) before the bubble popped. Consequently, Zions got hit harder and has a longer road back.

For the first quarter, Zions saw deposits and loans shrink (down 2.5% and 2.9%). On top of that, the credit picture is not quite as strong. The absolute level of non-performing assets seems to have stabilized, but the margin between credit provisioning and charge-offs is much tighter here. Perhaps Zions has an exceptional ability to determine likely loan losses, and so can have smaller provisioning expense, or maybe the bank is less willing to charge off a loan. In either case, this is a yellow flag to me, as is the company's high efficiency ratio of 68% (higher is worse).

Regions Financial
Like Zions, the quarterly results from Regions Financial (NYSE:RF) look more like stabilization than improvement. Deposits did grow (up about 2%), but loans fell (down 2.8%). On a relatively happier note, a big chunk of the drop in loans was due to a drop in real estate investor loans; the decline in commercial loans, mortgages and home equity lines was much more moderate.

On the credit side, charge-offs seem to have stabilized, and management does not expect to significantly build reserves in the second half of the year after the expected peak in the second quarter. As with Zions, though, the margin between provisions and charge-offs is narrow; if management is right, that will be good for earnings, but it is a risk.

A Bright Spot
Perhaps we have saved the best for last with Buffalo's M&T Bank (NYSE:MTB). Deposits at this bank grew 12% in the first quarter and loans grew by 5%, while credit quality seems to be quite good on a relative basis. Charge-offs came in at 0.74% and the allowance for loan losses was 1.73%; quite low ratios on a relative basis. M&T, too, has seen the gap between charge-offs and provisions narrow and management seems more comfortable that credit conditions have stabilized.

What to Do
That strong rise in banking stocks this year has set up a pretty unappealing choice for investors looking to add money in this sector. Investors can either invest in high-quality banks with an expected return not much different than a reasonable margin of safety, or they can open the box of broken toys and try to cherry-pick the eventual survivors among those banks still struggling.

I would suggest taking a good look at quality names like USB, MTB, Wells Fargo (NYSE:WFC), PNC (NYSE:PNC) and so on. They may not have as much sizzle as the smaller banks that still have a few spots, but this does not quite feel like the time to get aggressive again in this highly-leveraged and politically vulnerable sector. (For related reading, check out How Do Banks Determine Risk?)

The Bottom Line
Some key points seem to be coming out of this bank earnings season. First, new loans are not being made with any urgency. Second, strong banks are winning at the expense of weaker banks. Third, and perhaps most important, we are not out of the woods yet. Every bank executive seems nervous about their commercial lending business and there is an ever-present concern that any wobbling in the business community could trigger more defaults in residential/consumer lending and perhaps trigger a double-dip recession. (For more, see Analyzing A Bank's Financial Statements.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!