Integra Bank


has slipped as the economy slides, this small-cap bank may be just the answer for investors banking on an economic recovery in 2002.

Let's kick off the new year by looking at this Evansville, Ind.-based bank, which has $3.3 billion in assets and 78 branches in Indiana, Kentucky, Ohio and Illinois.

A stable bank, Integra has a loan portfolio that won't likely get it into trouble. However, the rapid decline in interest rates has had a marked impact on earnings. For example, in the quarter ended Sept. 31, 2001, earnings declined 22.5% compared with the same quarter last year. And, if you remove gains from nonloan investment activity, Integra's third-quarter operating earnings were down nearly 55% compared with a year ago. The lower results continue a trend that started in the first quarter as the

Federal Reserve

began to push interest rates lower early in the year.

Losing Interest?

"Interest rate cuts have hurt Integra's highly sensitive balance sheet," notes Ross Demmerle, a bank analyst at Hilliard Lyons, in a recent note to clients. "Non-interest income improved 18%

in the third quarter from greater service charges on deposit account, higher trust revenues and sales of insurance annuities. To date, the timing of the purchase and sale of mortgage-backed securities has been outstanding. Securities gains equaled 31% of pretax income this quarter." Demmerle rates the stock a hold, and his firm has provided banking services for Integra.

In short, the income (or yield) from Integra's assets -- primarily interest income from its loan portfolio -- has declined at a rate greater than the costs of funds to cover those loans, mostly deposits and short-term borrowing.

The bank's management recognizes the problem. "Our near-term asset sensitivity was again impacted by the continued decline in market interest rates during the third quarter," said Michael Vea, Integra's chairman, president and CEO, in a statement announcing recent earnings. "The impact on our near-term asset sensitivity of approximately $416 million, together with the drop in market interest rates, placed downward pressure on our net interest margin and resultant net interest income."

According to Integra's filings with the

Securities and Exchange Commission

, for every 2% change in interest rates, the bank's net interest income adjusts by nearly 7%. "This bank is much more asset-sensitive than its peers," says SunTrust Robinson Humphrey analyst Christopher Marinac, who does not formally follow Integra. "Their shock test to net interest income is nearly plus or minus 7% for every 200 basis-point change in interest rates. When rates increase, the bank has a nice comeback, but it also explains why earnings have been so soft this year."

So if you're looking for an economic recovery and stable-to-higher interest rates, Integra provides a way to play that scenario among small-cap banks.

"Given the backdrop of a more stable interest rate environment and continued economic stability, we envision a return to a more normal level of profitability as we proceed into next year," Vea said in the statement.

That trend may soon emerge, according to Marinac. "You don't necessarily have to see Fed tightening for things to improve," he says. "You just need some stability in short-term interest rates, something you are already beginning to see. Short-term futures are beginning to suggest the Fed easing is close to done, and longer term, the futures market suggests rates could increase later in the year."

Cashing In?

Another potential catalyst for Integra shareholders would be an increase in regional bank merger activity. While the M&A game among financial institutions has slowed with the economy, economic renewal would likely be accompanied by renewed interest in consolidation.

While Integra is a well-run, small regional bank, the company and its shareholders would benefit from the efficiency of a bigger size. One possible partner would be


(BBT) - Get Report

, the Winston-Salem, N.C., bank that has indicated it wants to grow in Integra's territory. A company like BB&T could immediately improve Integra's 12% return on equity and 0.86% return on assets.

Given recent transactions, an offer could bring $26 to $30 a share for Integra shareholders.

A Tough Year for Integra
It's well off this year's high, but it may rebound
along with the economy

Weighing the What-Ifs

The risks associated with Integra are really "what-if" questions. What if the economy doesn't rebound? While further interest rate cuts would clearly hurt Integra further, stability would improve the company's performance. As rates have fallen since October, fourth-quarter results could be disappointing, so you may want to wait until annual results are announced before establishing a position in the stock

I still like Integra's prospects as the economy begins to re-energize, especially when you add in the possibility of a partner to enhance shareholder value. Concern about the economic recovery's actual strength is my only caveat, so I give Integra 2 1/2 barrels. I'll really like the stock if it trades at or below $20 per share.

(For an explanation of our barrel rating system,

see our recent description.)

Looking Back

Next week, I'll take a final look back at my 2001 picks and provide another pick for the year ahead.

Do you have candidates for Bottom of the Barrel? If so, shoot me an email with the company's name, why you think it qualifies and your full name and hometown. If we profile your suggestion, we'll send you a


gift to commemorate your pick.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.