NEW YORK (
) -- While the overall picture looks scary for regional banks in 2010, there are big opportunities for good stock pickers.
As a group, the largest banks look far better than smaller ones.
The government stress tests endured by the 19 largest banks, from giants like
Bank of America
to relatively smaller players like
Fifth Third Bancorp
were "actually a replication of the Great Depression," argues Sandler O'Neill + Partners' chief strategist Robert Albertson.
As a result, those banks are in good shape.
"Having passed those tests and raised the attendant capital required, they're pretty bullet-proof if not overcapitalized," Albertson says.
By contrast, smaller banks have not raised as much capital and Albertson argues they will find it far more difficult to do so than many bank investors realize.
"When the top 19 went through the
stress testand they had to go out raise $60 billion in three weeks or whatever it was, we all kind of dropped our jaws. It just went and happened. They did it."
Albertson estimates those banks represent about two thirds of the assets in the banking system. Therefore, he believes the rest of the banks will need to raise about $30 billion between them.
People say well 'What's another $30 billion?' My answer is, 'It's $30 billion over 8000 banks,'" Albertson says.
Further problems for the regionals come from the fact that the smaller they are, the more likely they are to have a heavy concentration of commercial real estate loans. Albertson says that while the banking sector as a whole has just 8% of its outstanding loans in commercial real estate, regional banks have anywhere from 20-60%. (Fred Cannon, strategist at Keefe, Bruyette & Woods, offers broadly similar numbers, arguing the largest banks have 10-12% commercial real estate exposure versus 35% for the regionals.)
Kevin Rendino, portfolio manager of the BlackRock Basic Value Fund, made a similar argument in an interview with
last week. However, Rendino believes even large regional banks that were part of the Fed's stress test, like Fifth Third and
, look heavily exposed to commercial real estate and shareholder dilution relative to the very largest names, like Bank of America and
There is a problem, however, with leaving regional banks out of your portfolio altogether, argues Fred Cannon, co-director of research at Keefe, Bruyette & Woods. While he agrees that staying away from regional banks broadly is a good idea, he believes some will do extraordinarily well at raising capital, if necessary, and buying failed banks. Cannon says there could easily be 400 failed banks next year in the U.S., about three times what we've seen in 2009. Bad as it sounds to some, others see opportunity.
"There is almost a gold rush going on of investors who want to capitalize on that by buying failed banks or having their favorite regional banks buy a failed bank and roll those up," Cannon says.
Many private equity players had hoped to buy banks on their own, but meeting regulatory resistance, they have begun backing regional players who they think can buy failed competitors.
A good example is
East West Bancorp
. The Bay Area bank, which caters to Chinese Americans, bought, another Bay area bank with a similar customer base last month. While the strategic fit was obvious, many analysts had thought East West Bancorp was itself too weak from a capital perspective to buy UCBH. But savvy investors, including private equity firm Corsair, were only too happy to add to East West's coffers.
Federal Deposit Insurance Corp.
announced the deal between the two banks on Nov. 6, East West's shares are up more than 65%. A stake in UCBH, of course, is now worthless. So in theory a regional bank portfolio could be outstanding--if it leaves out the UCBHs and loads up on the East West Bancorps.
KBW has put together a list of about 30 banks (see chart above) it believes are likely to benefit from the regional bank shakeup, including large names like
and BB&T, and quite a few sleepers, like
Home Federal Bancorp
, a bank headquartered in Nampa, Idaho with less than $900 million in assets.
Written by Dan Freed in New York.