Investors who have been betting big on regional bank shares got a bit of vindication last week when Wisconsin-based lender Marshall & Ilsley Corp. agreed to be sold at a big premium.
Hope about other deep pocketed buyers like Canada's BMO Financial Group, whose all-share offer was for about a third more than where M&I shares closed the day before, could be part of the reason for an improbable surge in regional bank stocks this year.
On Tuesday, Toronto-Dominion Bank said it was buying Chrysler Financial from Cerberus Capital for $6.3 billion, in another sign of how keen some banks are on the potential for U.S. economic recovery.
A rally in bank stocks was already well underway even before these deals. Huntington Bancshares Inc., which recently said it would repay the U.S. government's bailout funds, and Zions Bancorp have both gained over 75 percent since the beginning of the year.
Other regional banks including KeyCorp and Fifth Third, which have gained 52 and 45 percent respectively this year, have also been strong.
Analysts said the recent rise in interest rates -- and the overall economic recovery -- will help regional banks' main businesses recover. Larger rivals are facing additional challenges, including increased regulatory pressures and slowdowns in other lines of business, including investment banking.
"Regional banks are the ones that will really see the benefit from the decline in charge-offs and the improvement in credit quality and overall economy ... given that they derive the majority of their revenues on the net interest income side," said one analyst at a money management firm that invests in regional bank stocks.
Banks profit from funding themselves at low short-term rates and lending money out at relatively higher longer-term rates. As long-term bond yields rise, regional banks that focus mostly on lending and taking deposits are able to earn more interest from their loans.
The spread between long-dated 10-year notes and short-dated two-year notes has risen to 2.75 percentage points as of today, from 2.13 percentage points just two months ago, and the expectation is for long rates to continue to rise.
Meanwhile, "large money center banks derive a decent amount of income from mortgage banking and securities underwriting and fixed income. A lot of those markets can be more volatile," the analyst said.
A slump in trading and securities volumes cut into revenues this year at large financial firms like Goldman Sachs Group Inc., Morgan Stanley, JPMorgan Chase & Co. and Citigroup Inc.
Bank stocks overall have recovered somewhat this year, with the S&P 500 up 12 percent and the wider KBW Banks Index up about 17 percent since the beginning of the year. Financials make up the largest sector in the S&P 500 after technology and their participation is seen as key to a sustained market rally.
Analysts and investors especially see Huntington, which showed its health with its ability to repay TARP, as a leader for the regional banks.
"The losses in the loan portfolio have ended up being not quite as severe as expected, and they became profitable about a year sooner than the Street expected," said Jeff Davis, bank analyst at boutique bank Guggenheim Partners.
"It was a stock that was priced at a pretty good discount at the beginning of the year ... Their fortunes turned and it's been a great stock," he said, though he added that he does not expect another 75 percent increase in the bank's share price over 2011.
Even after the year-long run-up in their share prices, regional bank stocks are relatively cheap. Sandler O'Neill analyst Scott Siefers values Huntington at 1.4 percent tangible book value and Zions at 1.1 percent tangible book value - relatively in line with the 1.4 percent tangible book value that the S&P regional banks are trading at.
The regional bank shares are relatively more expensive than Bank of America Corp., currently trading at 1 time tangible book value, but in line with JPMorgan Chase and Citigroup, and cheap relative to Wells Fargo & Co., which is trading at almost 2 times its tangible book value, Siefers said.
Questions remain for the regionals, most of whom are still struggling with soured real estate loans and other legacies of the financial crisis, including TARP. But signs of fundamental improvement have heartened investors.
"We ended 2009 on a pretty sour note for a lot of bank stocks," Siefers said. "Broadly speaking, it seems like the industry's gotten its arms around credit issues."
"We are getting more clarity on the capital side, but there are other ancillary issues like the regulatory environment, which is still a wild card."
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