Not all bank stocks are bad. In fact, some could make investors a lot of money this year. "There are regional markets to avoid like Florida and Arizona, where the housing exposure has led to recession," says Anton Schutz, portfolio manager for the $27 million ( BURFX) Burnham Financial Industries fund. "But the Northeast did not suffer from that much overbuilding and is still in very good shape banking-wise." Schutz's three favorite regional banks include two based in New Jersey, Investors Bancorp ( ISBC) and Hudson City Bancorp ( HCBK), and one located up I-95 in Connecticut, People's United Financial ( PBCT). The trio makes up almost 30% of the assets in the 22-stock fund, so there is no doubt that Schutz expects big things in 2008. More importantly, Schutz is confident that these banks, unlike the money-center banks surrounding them, are subprime-free. "All three are conservative lenders that have too much capital that can be deployed in new loans with better spreads," says Schutz. "There is no subprime exposure here." Schutz's fund is only down 3.4% year to date, more than a full percentage point better than the S&P 500 and two percentage points superior to its Morningstar category benchmark. Over the last three years, the four-star fund has returned slightly over 7% annually, over five percentage points better than its Morningstar yardstick.
Time's Right for Regional Banks
Despite his affinity for the smaller lenders, Schutz has not written off the megabanks. In fact, he believes market forces have pushed the valuations of banks like Citigroup ( C) and Bank of America ( BAC) down to extreme levels not seen since 1990. "If we go into recession, it's not going to be like the deep 1990 recession, but the mild 2001 recession," says Schutz. "So they will snap back." Also aiding their recovery will be foreign interest. According to Schutz, the falling dollar has made them look cheap to foreign banks looking to buck up their U.S. presence. Already, the market has witnessed Canada's Toronto-Dominion ( TD) take out Commerce Bank ( CBH), on the heels of a strong Canadian dollar, as well as Asian and Middle Eastern sovereign funds taking large stakes in major Wall Street banks and brokerages. "Make no mistake, it's not just propping them up or throwing good money after bad," says Schutz. "These are savvy investors that see an opportunity. They would not invest if there was no upside." A third factor favoring banks big and small is the steepening of the yield curve. Banking institutions thrive on borrowing cheap and lending higher and longer. "The yield curve is starting to take shape and it will get much steeper," says Schutz. "The Fed is pushing on the short end, and leaving the long end alone to the whims of rising inflation." Speaking of the Federal Reserve, Schutz theorizes that Bank of America's decision to acquire the rest of Countrywide ( CFC) is critical to the Fed's economic plan. And it is also good news for the entire banking industry looking to lower costs. "Because of Countrywide's desperation to do business, they kept deposit rates artificially high across the country," says Schutz. "Other banks were forced to react in kind and pay higher rates on CDs. But Bank of America has other income streams and will not overpay for deposits. "A lot of bank CEOs were complaining, but now they are relieved," he adds. If Schutz is right, the same may soon be said for investors owning financial stocks.