Bangalore: A slowly recovering US economy and waning credit costs may help the stocks of small- and mid-sized banks show up again on investors’ radars.
Margins at regional banks such as Western Alliance Bank, Private Bancorp, Comerica, Huntington Bancshares and several others are expected to get a boost from stabilizing non-performing assets and lower costs of funding in the coming quarters.
“Following five years of underperformance relative to the S&P 500, we now expect a multi-year recovery in the stocks of small- and mid-cap banks,” analyst Terry McEvoy of Oppenheimer & Co said.
The KBW Regional Bank Index has shot up 13% so far this year, significantly outperforming the broader S&P 500 index, which has risen only 2%.
Although these banks may not return to profitability until at least next year, revenue trends for them are expected to improve in the second half of the year and into 2011, backed by improving macroeconomic trends, analysts say.
The biggest concern for these institutions is their exposure to commercial real estate (CRE), but to a large extent it has already been discounted in their stock prices, Bernard Baumohl, chief global economist at the Economic Outlook Group, said.
Industry watchers are keeping a close eye on losses stemming from the CRE portfolio of financial institutions and will use it to determine the health of the banking industry.
These banks could lose more money in the event of a higher-than-expected default rate on CRE loans.
“Frankly, I do not expect that to happen because the US economy appears to be coming back quicker than many other forecasters had expected,” Baumohl said.
Any improvement in the macro indicators such as jobs data or even the housing market trends will bode well for these banks, which rely on the well being of the economy for healthy growth.
February data showed the United States lost 36,000 jobs, better than consensus expectations of a 75,000 decline.
US housing starts rebounded more strongly than expected to their highest level in six months in January, while permits fell slightly less than forecast.
William Cheney, chief economist for John Hancock Financial Services, said he expects the overall US economic growth to be 4% to 5%, outpacing the consensus expectation of 3 percent to 3.5%.
“And if we get those kinds of numbers, then all the issues which are weighing on particularly small- and medium-sized banks will be a little less severe.”
Buyers on the prowl
Consolidation is going to be the buzzword in the small- and mid-cap banking space over the next two years, as buyers get more clarity on the troubled balance sheets of possible target companies.
“We will probably see a lot more M&As take place in the Southeast and Southwest,” Baumohl of the Economic Outlook Group said.
While regulator-assisted buying of failed institutions is expected to gain ground in the coming months, analysts do not rule out purchase of weaker banks by the more healthier ones.
Earlier, banks were very worried about acquiring other banks whose credit quality they could not really understand, but now they have a better idea of what they are getting into, said Erik Oja, banking analyst at S&P Equity Research.
Oja said banks like TCF Financial Corp, which have repaid funds received under the US government’s financial bailout, will be in a better position to do some shopping.
Oppenheimer’s McEvoy sees FirstMerit Corp and Prosperity Bancshares Inc as potential buyers.
However, industry experts believe those who are risk averse may want to wait until there is little more information out there on the default rates on CRE and on the strength of the recovery.