The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
By Carla Pasternak
NEW YORK ( Street Authority) -- Banks are among the most hated institutions in the world, as they are seen by many as the epitome of corporate greed. Investors have no love to spare for banks, either. Financials were the worst-performing sector in the S&P 500 in 2011, with losses of more than 20%, compared with about 2% for the overall market.
But the sector is diverse, from big money centers such as Bank of America (BAC) to smaller regional banks such as Huntington Bancshares (HBAN - Get Report). There's a big difference between these two groups, and it's not just in their size.While both groups are federally chartered, they operate under different legislation. As a result, most regional banks focus on the traditional banking activities of savings deposits and mortgages and other loans. They devote little, if any, resources to securitizing mortgage loans or hedging with derivatives, as the big banks do. Most regional banks also aren't exposed to risky eurozone debt or faced with the massive mortgage lawsuits of their bigger brethren. With little exposure to subprime mortgages, regional banks largely dodged the debt crisis of 2008. These banks, as represented by the SPDR S&P Regional Banking ETF (KRE), lost 18% in 2008. By contrast, their big-cap brethren, represented by the SPDR S&P Bank ETF (KBE) suffered a loss of more than 47%. Regional banks didn't fare as well as their large-cap counterparts in 2009, however, amid concerns that the weak real estate market would affect their residential and commercial real-estate loans. As of March 2010, 54% of the assets of smaller banks were related to real estate, compared with 43% of the 25 largest U.S. banks, according to Bruce Tuckman, author of Fixed Income Securities. But now they are back on the radar screen and starting to attract investor attention. Regional banks gained close to 15% in the past three months, compared with less than 5% for large-cap bank stocks.
What's driving their recent outperformance? With fewer issues on their plate than the larger money centers, regional banks are benefiting from stronger industry fundamentals. While revenue is being pressured by near record-low interest rates on their loans, loan volume is picking up. U.S. Federal Reserve data for the third quarter of this 2011 showed that business loans rose 2.4% from the second quarter to just over $1 trillion. Consumer credit-card loans also rose slightly (0.7%) from the second quarter. Credit quality is also improving. Careful credit checks are resulting in fewer delinquent loans, and banks don't need to set aside as much money to cover bad loans, so costs are lower and earnings are higher. Consider Huntington Bancshares, one of the nation's largest regional banks. A 5.3% increase in consumer loans in the third quarter helped increase total loans and leases by 4%. The quality of the loan book also improved, as problem loans accounted for only 0.92% of average loans, down from 1.98% a year ago. As a result, loan-loss provisions dropped from $119 million to $44 million, and net income rose 42%.