NEW YORK (
) -- The Midwest and Northeast couldn't be more different. And the same goes for their banks. For financial-services investors, zip code may be as important as earnings per share.
The banking industry is still in recovery mode, with the
KBW Bank Index
rising 8% this year through Tuesday's close at 55.46, following last year's 30% return. The index is heavily weighted to the "big four" U.S. banks, including
Bank of America
(BAC - Get Report)
While the biggest banks still trade at attractive price-to-earnings multiples, they also have the most "headline risk," as we saw last year when JPMorgan Chase surprised investors with its "London Whale" hedge trading loss. Shares of Bank of America are volatile as the company makes moves to settle investors' mortgage repurchase demands, appease regulators and otherwise put the credit crisis and a history of expensive ill-timed acquisitions behind it.
For investors with long-term horizons looking to move away from banks with
regulatory targets on their backs
, different regions of the country call for different approaches for picking stocks.
In the Midwest, the major focus is on banks' credit leverage as the economy improves. Large regional players including
of Columbus, Ohio, have continued to stress the importance of the manufacturing recovery, driven by increased car sales. There have been other encouraging comments pointing to an acceleration of economic growth in the region.
"People in the Pacific Northwest are very bullish on Seattle, which is encouraging," according to FIG Partners analyst John Rodis. "Historically, you see the coast get stronger, and then it moves inward to the Midwest."
Sterne Agee analyst Peyton Green says "banks in the Midwest have done better over the past year, with improved credit." Improving loan quality, combined with the gradual clearing out of problem loans and repossessed assets, means lower costs and, for many banks, an earnings boost from the release of loan loss reserves. "One of my favorite Midwest picks is in many respects a recovery play," Green says.
The next step for Midwest banks is to focus on loan growth, but "growth is hard to come by," according to Green.
Sterne Agee analyst Matthew Kelley says that in the Northeast, "we are continuing to see smaller community banks take more market share from the big players. This is a much larger theme in the Northeast than in other markets."
According to Kelley, large banks losing market share to more nimble local competitors include Bank of America,
, which is held by
Banco Santander SA
Green says investors are looking at "a regular-world frame work," with merger deals providing "much of a catalyst" for shares. "Bank stocks in the Northeast have not had much of a credit cycle to go through. The residential real estate bust was pretty much a nonfactor in the Northeast."
An example of a Northeast bank that has sailed through the credit crisis with robust loan growth and investor returns is
, which Green says "has had an incredible four-year run."
Sterne Agee has provided three "top ideas" among community bank stocks in the Midwest -- with one seconded by Rodis -- and another three buy-rated picks among Northeast names. There are different themes among the group, including credit recovery, expansion through acquisitions, loan growth, and a conversion from mutual to full-stock ownership.
Here are the six Midwest and Northeast community bank-stock picks, grouped by region: