Despite some dismal recent earnings reports from the banking sector, a number of bank stocks are still compelling for long-term investors.

As the market reaction to recent earnings reports from Wachovia ( WB) and Bank of America ( BAC) attests, banks stocks are certainly subject to headline risk over the short term, as the mortgage meltdown and housing slump continue to dominate the news.

The good news is that those banks are just two of the Five Fetching Bank Stocks identified by Ratings six weeks ago.

The list, which also included Huntington Bancshares ( HBAN), FirstMerit ( FMER) and Susquehanna Bancshares ( SUSQ), was intended to highlight attractive, high-dividend-yield bank stocks on the basis of the following criteria:

  • Dividend yield of at least 5%. This is normally quite greedy, but not in this market with so many beaten-down bank stocks.
  • Price-to-book-value ratio below 2.
  • Dividend payout ratio below 100%. As we are seeing with Washington Mutual, it can be quite scary if a holding company pays out more than it earns.
  • Nonperforming assets comprising less than 1% of total assets. (One of the listed companies, Huntington, has now exceeded this level of nonperforming assets.)

Six weeks is a very short time for a stock investment, and it borders on irresponsible to come to any conclusions in such a short period. Three of the "Five Fetching" bank holding companies, however, beat their respective indices for the period between the market closes on Sept. 7 and Oct. 25.

While no one can say how long it will take for the mortgage disaster to shake out, interest spreads should show strong improvement over the next few quarters. There should also be some easing of pressure on borrowers, with continued Federal Reserve rate cuts expected.

With that in mind -- and now that all five have reported third-quarter earnings -- let's take another peek.

In looking at the earnings releases, the nonperforming asset ratios don't always match the ones we derive from the more detailed regulatory filings, as loans past due 90 days but still accruing are often not included in reported "nonperforming loans." Another difference is that nonperforming loan balances with government guarantees are not always netted out.

Three of five bank stock pics beat their respective indices from Sept. 7-Oct. 25

Huntington Bancshares

Huntington, a Midwest regional player with $55 billion in assets, included the former Sky Financial Group in its financial statements for the first time in its Oct. 18 earnings release. This pushed its price-to-book ratio down to 1.01, exceedingly cheap and the lowest in the group. Huntington's stock has fared well over the six-week period, with a total return of 3.01%, compared with the S&P 500 financials index, which returned 0.15%.

Unlike some of the larger banks releasing earnings this past week, Huntington didn't report nasty surprises for the quarter. Net income was $138.2 million, down from $157.4 million for the same quarter a year ago but up from $80.5 million last quarter.

After taking a $60.1 million provision for loan losses in the second quarter, Huntington's asset quality declined slightly in the third quarter, and the provision was lowered to $42 million. While a detailed listing of nonperforming assets will probably not be available for a few weeks, when Huntington filed its regulatory financial statements, the earnings release stated that nonperforming assets comprised 1.08% of total assets as of Sept. 30, up from 0.97% the previous quarter, with the great majority of the problem loans being acquired from Sky Financial and marked down as impaired assets upon acquisition.

Huntington's nonperforming asset ratio is now above our 1% criterion. Oh well, what the heck? When you acquire a $17 billion bank, you're bound to find a few more problem loans than you detected when you did your diligence. Let's see what happens in the fourth quarter.


Wachovia has had extensive coverage of its earnings release and last Friday's conference call, with concern centering on its portfolio of option adjustable-rate mortgages acquired along with Golden West Financial in 2006. After the conference call, shares declined 3.6% to $46.40, slipping further to $45.09 at yesterday's close.

Wachovia reported net income of $1.69 billion for the third quarter, a 28% decline from last quarter and a 10% decline year over year. The biggest factor in the earnings decline was the corporate and investment-banking division's $1.3 billion in writedowns of structured-debt products. Also contributing to the weakened earnings was a provision for loan losses of $408 million, up from $179 million last quarter. Nonperforming assets increased 42% from last quarter, to $2.9 billion, or 0.39% of total assets.

All things considered, Wachovia's asset quality still measures up very well, considering the industry's turmoil.

Bank of America

CEO Kenneth D. Lewis was quite candid on a conference call with analysts when he commenting on the company's $1.5 billion in trading losses, saying "two-thirds were just mistakes we've made in judgment." Mr. Lewis certainly had the quote of the week: "I've had all the fun I can stand in investment banking at the moment." Of course, the aggressive cost-cutting he announced will not be fun for members of the company's investment banking staff. Net income was $3.7 billion, down from $5.8 billion last quarter and $5.4 billion in September 2006.

Not surprisingly, Bank of America increased its provision for loan losses, adding $2.03 billion to reserves, compared with $1.81 billion last quarter and $1.17 billion a year ago. Asset quality followed the industry trend, with a nonperforming assets ratio of 0.43% of total assets, up from 0.32% last quarter and 0.25% in September 2006. While Bank of America's asset quality slipped, it is still strong, and its reserve coverage is excellent, with the allowance for loan and lease losses covering 283% of problem assets.


The holding company reported another decent quarter, with third-quarter net income of $30.3 million, compared with $29.9 million last quarter and $31.2 million in September 2006. Respective returns on average assets and equity were 1.16% and 13.71%, essentially unchanged from last quarter but down from 1.22% and 13.93% a year ago.

The year-over-year earnings decline was mainly attributed to the narrowing net interest spread, as increased expenses were offset by lower provisions for loan losses. The company's asset quality continued to improve, with nonperforming assets (including nonaccrual loans, loans past due more than 90 days and repossessed real estate) of $47.3 million, or 0.45% of total assets. This compares with nonperforming asset ratios of 0.46% last quarter and 0.86% in September 2006.

The market was happy with the company's Wednesday earnings release, as shares rose 5% on the day to close at $19.51. Shares increased further, closing at $20.56 yesterday. FirstMerit gets the gold star for our group of five, with a total return (with a reinvested dividend) of 12.60% for the six-week period.

One concern with First Merit is its slow growth. Deposits have declined over the past two quarters and are flat for the past year. The loan portfolio has grown just 1.4% over the past year. Loan growth has been concentrated in commercial and auto loans, while the mortgages and home equity loan portfolios declined slightly. CEO Paul G. Greig stated that the company was focusing on improving asset quality and "quality organic growth with prudent and effective balance sheet management."

A conservative approach to deposit growth helped FirstMerit maintain a healthy net interest margin during a period of historically narrow spreads between short-term rates paid out to depositors and long-term rates collected on loans and securities. First Merit's net interest margin for the third quarter was 3.61%, compared with 3.68% in the third quarter of 2006. In comparison, the industry's aggregate net interest margin was 2.95%, slipping from 3.03% in September 2006.

Susquehanna Bancshares

Susquehanna saw its stock price drop over 5% after its third-quarter earnings call on Wednesday morning. However, the stock price recovered over the next two days, closing at $19.14 yesterday, with a 3.07% total return for the six-week period. Net income for the third quarter was $19.9 million, compared with $9.8 million last quarter (with $11.7 million in losses on securities sales) and $25.2 million in the third quarter of 2006.

Asset quality is good, as nonperforming assets comprised 0.53% of total assets, compared with 0.51% last quarter and 0.81% a year ago. The market continues to dislike Susquehanna, which trades at just 1.1 times book value, with an estimated dividend yield of 5.25%.

Susquehanna's loan growth has been strong, with most of the new lending concentrated in commercial loans, which grew 26% over the past year to $1.2 billion. While deposits grew just 2% over the past year, to $6 billion, the institution has maintained a good net interest margin, which was 3.64% for the third quarter of 2007, down from 3.76% a year ago.

Susquehanna's agreement to acquire Community Banks ( CTMY), of Harrisburg, Pa., for $860 million in cash and stock has been approved by both holding companies' shareholders. The deal is still expected to be completed Nov. 16. This will bring Susquehanna's assets to $12 billion, with about 230 branches in Pennsylvania, Maryland and New Jersey.
Philip W. van Doorn joined Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.

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