Three Regional Banks to Watch in 2010 - TheStreet

Three Regional Banks to Watch in 2010

While the banking sector still faces challenges, analysts have tabbed U.S. Bancorp, BB&T and Fifth Third Bancorp as regional banks worth a long look from investors in the coming year.
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NEW YORK (TheStreet) -- U.S. Bancorp (USB) - Get Report, BB&T (BBT) - Get Report, and Fifth Third Bancorp (FITB) - Get Report look like the prime picks from among the regional banks in 2010.

Admittedly, the group as a whole has a long way to go before the sector returns to normalcy, given continued asset troubles and typically less business line diversification. But because of initiatives like taking advantage of industry dislocation to make choice acquisitions and dealing with loan troubles aggressively early in the financial crisis, these three banks have consistently been mentioned as top picks by analysts covering the sector.

U.S. Bancorp

U.S. Bancorp kept its strategic focus after the credit bubble burst, pursuing appealing deals despite the economic uncertainty. To date, the Minneapolis-based bank has purchased four failed banks with the assistance of the

Federal Deposit Insurance Corp..

(along with a set of branches in Nevada from BB&T and several other non-bank acquisitions), and many say it is likely to keep up with that fill-in approach next year.

The bank is viewed by many on both Wall Street and Main Street as a safe haven, and it's seen its core deposits grow accordingly. While many of its big bank brethren are just now moving to repay TARP, U.S. Bancorp had ample capital levels to clear out its $6.6 billion bailout tab back in June, and it repurchased warrants associated with the Treasury's investment a little more than a month later.

U.S. Bancorp has approximately $265 billion in assets and is the parent company of U.S. Bank, with operations in 24 states. It is probably most well known for its retail banking outfit, primarily located in the Midwest.

But the company is much more than a plain vanilla bank. It has a large payments services business and provides wealth management services for individuals and corporations. And while U.S. Bancorp's commercial and commercial real estate loans areas have been a source of weakness, the significant fee revenue that the company earns from the other businesses and a generally conservative lending strategy has offset a good measure of the pain stemming from the financial crisis.

U.S. Bancorp shares are down about 11% year-to-date, while the Keefe Bruyette & Woods bank index has fallen some 4% in 2009. The company has remained profitable throughout the crisis, albeit at a lower level than past years. Still, revenue in the third quarter alone jumped 26% compared to the year-earlier period, reflecting both acquisitions and organic measures of deposit-taking and lending.

"While any bank is admittedly a prisoner of the economy to a great degree ... the victors will be the de-TARP'ed, de-risked, well-managed, revenue-diversified major regional banks, with U.S. Bancorp at the top of this (admittedly small) heap," Bush wrote in her note.

U.S. Bancorp's recent acquisition of FBOP Corp. of Oak Park, Ill., with $18 billion in assets and 150 branches in states that are important to U.S. Bancorp's Midwestern and Western presence, seems to be the "penultimate U.S.Bancorp-type deal, and we expect to see more of these for U.S. Bancorp in the coming year," Bush added.

U.S. Bancorp, which expects loan losses to peak next year, has also indicated that it plans to increase its dividend in the coming months, one of the few banks besides

JPMorgan Chase

(JPM) - Get Report

that has gone on the record about its ability and willingness to do so, despite the uncertain economy.

Still it's no secret that U.S.. Bancorp's credit losses have intensified along with the broader sector. In 2007, losses were $792 million, or about 54 basis points of loans.. This year that number will be roughly $3.8 billion, or about 2.2% of its loans, according to Bush. But once losses return to a level near 2007, U.S. Bancorp could add roughly $1 after taxes to earnings on an annual basis and "a whole bunch more to its stock price," Bush wrote.

BB&T

BB&T of Winston-Salem, N.C. is another large regional bank likely to benefit from the continued consolidation of failed banks and, like U.S. Bancorp, it's one of the institutions being sought out by pennysavers and investors alike as a safe haven.

"The biggest theme for regional

banks will be the purchase of failed banks," says Fred Cannon, Chief Equity Strategist and co-director of research at Keefe, Bruyette & Woods, about 2010. "One hundred and thirty banks failed this year. That number could easily double or triple next year. The market has been rewarding banks that are able to do deals." BB&T may fit that bill.

With more than 1,800 branches spread between 11 states, the company has a marked presence as a Southeast survivor. The ninth largest bank by deposits and market cap also has sufficient capital levels (including the ability to repay $3.1 billion in bailout funds in June) and has been eyeing federally-assisted deals all along. In August, BB&T completed its largest acquisition ever by purchasing $22 billion in assets and $20 billion in deposits from Colonial Bank after the Birmingham, Ala.-based company was taken into receivership by the FDIC. The acquisition gave BB&T not only market share in Colonial's home state but also Florida and Georgia as well as branches in Nevada, which BB&T eventually sold to the aforementioned U.S. Bancorp.

Observers say BB&T should be able to capitalize on further dislocation in its territory as commercial credit cycle plays out.

BB&T specifically could benefit because "there are still a lot of banks with construction heavy portfolios that will fail in the Southeast," Cannon says. "A lot of it is just because of the real estate boom there and the sheer number of banks."

Large regional banks such as BB&T should also be able to grab market share as a result of the ongoing industry consolidation.

KBW analysts predicted while loan balances are likely to fall across the sector but said: "We would not be surprised to see middle-market lending increase at larger regional banks," according to an industry note. "This would be due to increased demand from businesses that feel 'under serviced' by the largest institutions who may be motivated to retain or compete for only the larger-size loans and accounts in order to leverage their broader, global product platforms mentioned previously."

That's not to say that BB&T is totally immune to the credit crisis. It's experienced a fair share of deteriorating loans, but the stock is down just 6.6% year-to-date based on Thursday's close, and it's looking on pace to end the year in the same $25 a share range where it started 2009. At that level it's doubed off a 52-week low of $12.90 on March 6.

Citigroup analyst Keith Horowitz upgraded BB&T to a buy rating at the beginning of December, saying the stock is "attractively valued" given pretax pre-provision earnings potential vs. remaining losses embedded in its loan portfolio.

"We estimate BB&T will emerge from the credit cycle with nearly $3 billion of excess capital that can be deployed through M&A and share repurchases," he writes. Horowitz also raised his 12-month stock price target on BB&T at that time by $2 to $34.

Fifth Third Bancorp

Fifth Third Bancorp isn't an obvious choice, given its primarily economically challenged Midwest territory, and the fact that it's yet to pay back its $3.4 billion in government bailout funds like U.S. Bancorp and BB&T, but the Cincinnati-based company could be poised to break out of its rut sooner than later, several analysts contend.

The $111 billion-asset Fifth Third was hit early in the credit cycle mainly by troubled residential mortgages, particularly given its presence the economically challenged Midwest and in Florida.

Yet Todd Hagerman, an analyst at Collins Stewart, who overall is cautious on the regional banks given continued credit quality problems and capital issues, says Fifth Third is "pretty far along in terms of cleaning up the credit problems."

"They significantly strengthened the balance sheet, both in additional capital as well as significantly higher loan loss reserves.," Hagerman says. "And it's a franchise that continues to take market share, notably in its Midwest market."

The company has realized roughly $4.3 billion in charge-offs since June 2008 and has built its loan-loss ratio up to 4.69% -- near the top of the industry, Morgan Keegan analyst Bob Patten writes.

"Management expects net charge-offs to be lower in the fourth quarter due to a reduction in C&I

commercial and industrial losses, and also anticipates that future reserve building will lessen from the pace seen earlier in the cycle -- both encouraging signs that credit losses could be nearing a peak," Patten writes.

Furthermore, given its position in the distressed Midwest markets, Fifth Third is also likely to be a beneficiary of FDIC-assisted acquisitions of failed banks, "which should provide them with cheap, low-cost deposits and position them for stronger long-term growth," he adds.

Fifth Third has also been among the regional banks most active in restructuring troubled loans and re-default rates of these restructured loans are low compared to other banks, writes Credit Suisse's Craig Siegenthaler.

Siegenthaler expects Fifth Third's shares to rise to $15 by the end of 2010, according to a Dec. 2 note, implying plus-50% appreciation from their close at $9.55 on Thursday.

--Written by Laurie Kulikowski in New York.