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2 Midwest Community Bank Stock Picks

NEW YORK ( TheStreet) -- There are plenty of community banks in the Midwest that are posting solid loan-growth numbers.

Stocks of strong community banks tend to trade at a significant premium to the largest U.S. banks, reflecting the prospect for continued earnings growth, in line with the loan growth as the Midwest economy continues to recover, while also reflecting investors' continued discomfort with the big banks, amid a regulatory and political onslaught.

FIG Partners analyst John Rodis covers 19 smaller regional banks, nearly all of which are located in the Midwest. At Friday's market close, the 19 stocks were trading at an average of 15.5 times his 2014 earnings estimates.

That's a pretty high valuation compared to the "big four" U.S. banks:
  • Shares of JPMorgan Chase (JPM - Get Report) closed at $54.52 Friday and traded for 8.9 times the consensus 2014 earnings estimate of $6.10 a share, among analysts polled by Thomson Reuters.
  • Citigroup (C - Get Report) closed at $51.32 Friday and traded for 9.2 times the consensus 2014 EPS estimate of $5.57.
  • Bank of America (JPM - Get Report) closed at $14.45 Friday. The shares traded for 10.6 times the consensus 2014 EPS estimate of $1.37.
  • Wells Fargo (WFC) closed at $43.23 Friday and traded for 10.8 times the consensus 20143 EPS estimate of $4.02.

The valuations of the big four don't necessarily reflect their earnings power relative to each other. For several years, the strongest earnings report among the group has been Wells Fargo, however, the cheapest name to 2014 earnings estimates, JPMorgan Chase, has been the second-strongest when looking at returns on tangible common equity.

JPMorgan's valuation, and the low stock valuations for all of the largest U.S. banks, reflect the continued regulatory and political uncertainty, as the bar for capital strength keeps being raised, as the legacy mortgage mess continues to be worked through, and as other regulatory matters, including the Durbin Rule and the Volcker Rule, remain unsettled.

When discussing the lower valuations for large banks relative to community bank stocks, Rodis says, "There's not as much franchise value there, because of so much more complexity."

Many community banks also have a takeout premium baked-into their share prices. But there's no way Bank of America is going to be taken over.

Strong Loan Growth

"Loan growth was relatively strong and in most cases better than expected," according to Rodis, who last week summarized in a report the second-quarter performance for the banks he covers.

"The growth for most banks continues to be driven by commercial loans (C&I and CRE) and to a lesser degree by consumer loans including mortgages for some banks."
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