Still Negative on Regional Banks

We were interested in finding out the state of some regional banks, in hopes that would improve our perspective and understanding of what may be ahead for financial institutions in general, in some way. Joining us today is Zacks senior financials analyst Eric Rothmann for his take.

Let’s start with Hudson City Bancorp. What’s your outlook here?

Even though Hudson City Bancorp (HCBK) shares trade at a discount to the peer median (on a P/E basis), with 67% of the loan portfolio in residential real estate in the New York metropolitan area. Considering the industry overhangs, we remain cautious given the current valuations. Our rating remains a Sell, though a weaker one. Our six-month price target of $15.50 per share equates to a negative 11.7% expected total return.

The loan portfolio expanded by 2.9% year-over-year to $24.9 billion in 1Q08 from 24.2 billion in 1Q07, with purchased loans representing $543.4 million of the increase. The provision for loan losses amounted to $2.5 million in 1Q08 up 25% sequentially. The amount of loan provision for the corresponding period last year was $0.3 million. Softening of real estate values should result in increased non-performing loan levels and elevated provisioning levels over the next year.

Non-performing loans amounted to $102.3 million at March 31, 2008, compared to $79.4 million at December 31, 2007. The ratio of non-performing loans to total loans at March 31, 2008 increased to 0.41% from 0.33% at December 31, 2007. We see no legitimate reason for HCBK to have a $20.2 billion securities portfolio (about 8.0% sequentially) funded by $25.2 billion in borrowings (up 4.5% sequentially).

Changing regions, where do you see Texas Capital Bancshares, presently?

Growth remains paramount, as 1Q08 average net loans expanded 25.9% year-over-year. Credit quality issues appear to have been contained presently. Following a review of the quarter, we have adjusted our 2008 and 2009 EPS expectation. In our opinion, Industry overhangs out-weigh TCBI’s results for the quarter, as such we continue to the shares of this company as a Hold presently.

Finally, we should make a note about Minneapolis-based U.S. Bancorp (USB).

Continued stress in the residential real estate markets and mortgage-related industries is impacting the company’s credit quality and has resulted in an increase in loan provisions, which should remain elevated through the balance of the year. Thus, we reiterate our Hold rating on the shares of USB, but fine-tune our 2008 and 2009 EPS to $2.50 per share and $2.65 per share, respectively, and moderated our six-month price target to $33.00 per share from $35.00 per share.

What is your overall outlook for this sector?

Our outlook for the regional banks and thrifts is negative. Despite the Federal Reserve s easings, credit quality concerns have resulted in a compression of Philadelphia Bank Index [BKX] over the past year. Though a lower interest rate environment has typically been more positive for bank stocks, given current concerns, the benefits are not visible presently. As a result of the meltdown in the housing and credit markets, the companies' direct or indirect exposure to mortgages have suffered the greatest negative effects.

Consumer lending, the bread-and-butter of many regional and local institutions, will continue to face significant headwinds to revenue growth, as the mortgage banking remains under pressure in 2008. Home equity lending should not be expected to offset this compression, as residential values are expected to moderate over the near term. While C&I (non-residential construction) has yet to experience the same issues as the mortgage industry, the small- and mid-cap banks typically have less exposure to C&I lending than the average large-cap bank. Small- and mid-cap banks should experience substantial challenges to show earnings growth in this economic environment.

Further, as the housing turmoil and soaring oil prices are affecting the consumers in general, we may see higher losses in other asset classes as well. Tighter lending and underwriting norms will limit the lending activity and further hurt profitability. There are some attractive valuations currently, but with the negative sentiment for the broad industry, we do not see any reason to be a broad-based buyer of the industry until we see a bottom to the housing market. For most of this year, credit quality should not be expected to experience any dramatic improvement, as the increased charge-offs should lead to increased provisioning for potential losses, potentially leading to results that are below consensus expectations. Also, deposit fees are also expected to struggle, as depositors may seek higher returns elsewhere in a declining rate environment.

Eric Rothmann is a senior analyst covering financial institutions for Zacks Equity Research.

Comments

[ED K]

THE REGIONAL BANKS IN N.J.,SUCH AS VLY,ISBC,HCBK,ETC WILL DO QUITE WELL AS THEY ONLY GIVE LOANS TO PEOPLE THAT ARE FINANCIALLY QUALIFIED AND THEY HAD LITTLE OR NO EXPOSURE TO THE SUB-PRIME DISASTER.I BELIEVE THEY WILL CONTINUE TO PROSPER.

[helplessobserver]

Please note that BBT Bank increased, repeat increased their dividend. Earnings are out on July 17. We can expect them to meet analysts estimates. We can also expect BBT to scoop up small community banks that are overextended in the MidAtlantic region.