10 Midwest Bank Stocks Revisited

NEW YORK ( TheStreet) -- There's a reason we said back in March that the Midwest regional story could be a compelling one for long term investors in bank stocks.

Out of the 10 Midwest Bank Stocks we highlighted at the end of the first quarter -- based on the upside implied by analysts' consensus price targets -- all but one have pulled back, and several have pulled back significantly.

Then again, since our last Midwest bank stocks roundup was published on March 30, the

The KBW Bank Index ( I:BKX) was down 13% through Friday's close at 46.01.

With the banking sector appearing to hit its 2011 bottom on July 18, and all the second-quarter numbers reported, this is a good time to revisit our previous Midwest bank stocks picks.

This group was selected in March by looking at banks headquartered in 12 Midwest states, and narrowing down the group to actively traded names with at least two "buy" recommendations from analysts, with the lowest forward price-to-earnings ratios based on consensus 2012 earnings estimates among analysts polled by Thomson Reuters.

This time out, we're looking at the same group, and analysts have had plenty of time to update their earnings estimates to reflect the Federal Reserve's final ruling on the Durbin Amendment, which will curb interchange fees that large banks charge merchants to process debit card purchases.

Last December, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act -- signed into law by President Obama in July of last year -- The Fed proposed a 12-cent cap on the interchange fees for banks with total assets of more than $10 billion, which was a drastic reduction from the average fee of 44 cents per transaction, charged by banks in 2009.

Following a bitter reaction from the banking industry, the Fed followed up in late June with a more reasonable 21-cent cap on interchange fees, plus an additional 5 basis points multiplied by the value of the transaction and "an upward adjustment of no more than 1 cent to an issuer's debit card interchange fee if the issuer develops and implements policies and procedures reasonably designed" to enhance fraud prevention.

You can be reasonably sure that all of the banks subject to Durbin will implement the enhanced fraud prevention measures.

As before, the selected Midwest Bank Stocks are generally trading at higher multiples to forward earnings than the largest U.S. banks:

Bank of America's ( BAC) forward price-to-earnings ratio was 6.4, based on Friday's closing price of $9.71 and the consensus 2012 earnings estimate of $1.52 a share, among analysts polled by FactSet. While the company's $8.8 billion second-quarter loss and continued mortgage woes have led to more than 15 earnings estimate cuts, the stock is still considered a value play by many analysts. As of Friday, half of the 26 analysts covering the company rated the shares a buy, while the other half had neutral ratings. The consensus 12-month price target among the analyst believers is $14.13, implying 46% upside for the shares.

For JPMorgan Chase ( JPM), the forward P/E was 7.1, based on Friday's close at $40.45 and the consensus 2012 EPS estimate of $5.68. The shares are trading for just 1.3 times tangible book value, according to SNL Financial, and analyst sentiment was very strong, with 23 out of 27 analysts rating the shares a buy, while the remaining four analysts all had neutral ratings. The consensus price target among analysts polled by FactSet is $54.76, implying 35% upside.

Citigroup ( C) had a forward P/E of 7.5, based on a closing price of $38.34 Friday and a 2012 consensus earnings estimate of $5.13 cents a share. Out of 22 analysts covering Citi, 16 rate the shares a buy, four have neutral ratings and two analysts recommend selling the shares. The consensus price target is $53.96, implying 41% upside.

Shares of Wells Fargo ( WFC) were trading for eight times forward earnings, based on Friday's closing price of $27.94 and a consensus 2012 earnings estimate of $3.51. Out of 24 analysts covering Wells Fargo, 17 recommend buying the shares, six have neutral ratings and one lonely analyst recommends bailing. The consensus price target is $36.43, implying 30% upside.

Moving back to the 10 Midwest regional plays, the regional economic recovery story is more compelling than the national one, as evidenced by the higher market multiples for most of the group.

That being said, the second-quarter action should serve to emphasize that even though analysts consider their 12-month price targets to be "long-term" outlooks for the shares, the slow pace of economic recovery and the continuing regulatory evolution post Dodd-Frank mean that a long-term investor's horizon needs to be several years.

Here are updated looks at the 10 Midwest picks, again in descending order by forward price-to-earnings ratio:

10. Associated Banc-Corp

Shares of Associated Banc-Corp ( ASBC) of Green Bay, Wis., closed at $13.65 Friday, down 10% year-to-date.

The company on April 6 repaid the government $262.5 million in bailout funds received through the Troubled Assets Relief Program, or TARP. Associated still owes the U.S. Treasury $262.5 million in TARP money.

Second-quarter net income was $25.6 million, or 15 cents a share, increasing from $15.4 million, or nine cents a share, in the first quarter and a net loss of $10.2 million, or six cents a share, in the second quarter of 2010. With credit quality improving, the second-quarter provision for loan losses declined to $16 million, from $31 million the previous quarter and $97.7 million, a year earlier.

With second-quarter net charge-offs -- loan losses less recoveries -- totaling $44.5 million, the company "released" $28.5 million in loan loss reserves, directly boosting earnings.

Second-quarter bright spots included a 3% increase in total loans from the previous quarter, with commercial and industrial loans increasing 8% during the quarter.

Following the earnings release, Morgan Stanley analyst Ken Zerbe reiterated his neutral rating on the shares, saying "It was a decent quarter and we believe ASBC is moving in the right direction, but an in-line valuation keeps us Equal-weight."

The shares trade for 13.8 times the consensus 2012 earnings estimate of 99 cents a share, among analysts polled by FactSet.

Out of 13 analysts covering Associated Banc-Corp, four rate the shares a buy, seven have neutral ratings and two analysts recommend investors sell the shares.

9. First Financial Bancorp

Shares of First Financial Bancorp ( FFBC) of Cincinnati closed at $16.01 Friday, down 12% year-to-date.

The company's regulatory quarterly dividend is 12 cents a share, translating to a dividend yield of 3.00%. In addition, First Financial announced that until it has "acquisitions or organic capital utilization rates that equal or exceed our capital generation rates," it will also declare quarterly variable dividends, to bring its dividend payout ratio up to 100%. Based on its second-quarter results, the company declared a variable dividend of 15 cents, so 27 cents will be paid-out on October 1.

The company further explained that it would manage "capital ratios at levels above our stated thresholds, which include a tangible common equity ratio of 7%, tier 1 leverage ratio of 8% and total risk based capital ratio of 13%." These ratios were 11.11%, 11.01% and 21.43%, as of June 30.

First Financial has a deal in place to purchase 16 branches from Liberty Savings Bank, FSB, of Wilmington, Ohio, for $22.2 million, which will include roughly $346.2 million in deposits and $143 million in performing loans in the Dayton market area, and is expected to close in the third quarter.

Second-quarter net income was $16 million, or 27 cents a share, compared to $17.2 million, or 29 cents a share, in the first quarter, and $17.8 million, or 30 cents a share, in the second quarter of 2010. The second-quarter net interest margin -- the difference between a bank's average yield on loans and investments and its average cost of funds -- was a strong 4.61% during the second quarter, increasing from 4.53% a year earlier.

The second-quarter earnings decline reflected reduced net interest income, as loan balances decline, and an increase in provisions for loss on loans not covered by Federal Deposit Insurance Corp. loss sharing guarantees. Results also reflected a 10% quarter-over-quarter decline in deposit account service charges to $5.1 million, and reduced fee revenue from debit cards and trust and wealth management services.

The second-quarter operating return on average assets (ROA) was 1.03% according to SNL Financial, which measure up well in the current environment, especially considering that first Financial Bancorp's profit was not driven by the release of loan loss reserves.

After the second-quarter results were announced, Hilliard Lyons analyst Ross Demmerle reiterated his neutral rating on First Financial and lowered his 2012 EPS estimate to $1.15 from $1.25, "owing to higher loan loss reserve provisions." Demmerle said the shares were appropriately valued "in light of an above average uncertain earnings stream and selling at premium price to book and price to earnings valuations."

The shares trade for 12.2 times the consensus 2012 EPS estimate of $1.31, among analysts polled by FactSet.

The eight analysts covering First Financial Bancorp are evenly split between buy and hold recommendations.

8. MB Financial

Shares of MB Financial ( MBFI) of Chicago closed at $20.19 Friday, returning 17% year-to-date.

The company owes $196 million in TARP money.

MB Financial reported a second-quarter net loss to common shareholders of $10 million, or 18 cents a share, compared to earnings of $4.3 million, or 8 cents a share, in the first quarter, and $16.6 million, or 31 cents a share, in the second quarter of 2010. The second-quarter loss resulted from $87 million in charge-offs on the sale of $281.6 million in loans, of which $156.3 were nonperforming.

As a result of the loan sale, MB Financial said its problem loans declined 53% during the second quarter. Nonperforming assets made up 2.40% of total assets as of June 30, declining from 3.96% in March. Loan loss reserves covered 2.19% of total loans as of June 30.

Following the second-quarter announcement, JPMorgan analyst Steven Alexopoulos reiterated his neutral rating for MB Financial, saying that after an important second-quarter marking the credit turnaround, "what we now believe will be required to get MBFI shares to the next level will be a rebound in top-line growth," and that the company's 9% annualized decline in period-end loans (excluding the loan sale) compared "poorly with peer regional banks showing a 3% annualized increase in loan balances in 2Q."

The shares trade for 11.7 times the consensus 2012 EPS estimate of $1.72, among analysts polled by FactSet.

The 12 analysts covering MB Financial are evenly split between buy ratings and neutral ratings.

7. FirstMerit

Shares of FirstMerit ( FMER) of Akron, Ohio, closed at $14.61 Friday, down 25% year-to-date.

The company reported second-quarter net income of $29.8 million, or 27 cents a share, compared to $27.6 million, or 25 cents a share, the previous quarter, and $31.5 million, or 32 cents a share, in the second quarter of 2010. The year-over-year decline in earnings reflected reduced service charges on deposit accounts, which was partially offset by higher ATM and other service fees, and an increase in personnel expenses.

The second-quarter ROA was 0.82% according to SNL. The net interest margin declined sharply to 3.77% in the second quarter from 4.00% the previous quarter and 4.02% a year earlier, reflecting "lower yields on new loan originations and the reinvestment of security cash flows into the investment portfolio at rates below historic averages."

Credit quality was good, with a nonperforming assets ratio of 0.70% as of June 30. The annualized second-quarter ratio of net charge-offs to average loans was 0.89% and loan loss reserves covered 1.59% of total loans as of June 30.

Following the second-quarter earnings announcement, Miller Tabak analyst Tom Mitchell reiterated his "Strong Buy" rating on First Merit, although he lowered his price target for the shares to $21.86 from $23.68 and cut his 2011 EPS estimate to $1.38 from $1.49 and his 2012 estimate to $2.02 from $2.16, saying that he expected "EPS expansion will be slower, and the Midwest economic recovery more sluggish, than we had previously estimated."

Tabak also said his estimates "assume FMER will make one $2B-earning-asset acquisition as of 10/1/2011, and another of the same size as of 7/1/2012."

The shares trade for 11.7 times the consensus 2012 EPS estimate of $1.25, among analysts polled by FactSet.

Four of the 10 analysts covering FirstMerit rate the shares a buy. The remaining six analysts all have neutral ratings.

6. TCF Financial

Shares of TCF Financial ( TCB) of Wayzata, Minn., closed at $12.72 Friday, down 13% year-to-date.

TCF has been a leader in the banking industry's fight against the Durbin Amendment, although the company announced on June 30 that it had requested dismissal of its lawsuit against the Federal Reserve, after the company was denied a preliminary injunction against the implementation of the Fed's final ruling. The final rule limiting interchange fees charged by banks with over $10 billion in total assets to merchants for processing debit card purchases goes into effect on October 1, and will further the reduction in TCF's fee revenue that began last year, when new rules limiting checking account overdraft fees went into effect.

Second-quarter net income was $29.8 million, or 19 cents a share, compared to $29.7 million, or 20 cents a share, the previous quarter, and $45 million, or 32 cents a share, in the second quarter of 2010. CEO William Cooper said that the company had "continued to evaluate potential strategies to mitigate the lost debit card interchange revenue," and that "TCF expects to be implementing its new product and fee structures in the fourth quarter."

The second-quarter ROA was 0.67% according to SNL Financial.

Following the second-quarter earnings announcement, Credit Suisse analyst Craig Siegenthaler reiterated his neutral rating for TCF, while reducing his target price for the shares to $16 from $17, saying that with clarity from the Federal Reserve's final ruling on the Durbin Amendment, the effect on TCF's earnings would be "$50-60M annually, slightly below our prior estimate of $64M."

The shares trade for 11.6 times the consensus 2012 EPS estimate of $1.10, among analysts polled by FactSet.

Out of 17 analysts covering TCF Financial, six rate the shares a buy, eight have neutral ratings and three recommend selling the shares.

5. KeyCorp

Shares of KeyCorp ( KEY) of Cleveland closed at $8.04 Friday, down 9% year-to-date.

Second-quarter net income attributable to common shareholders was $234 million, or 25 cents a share, increasing from $184 million, or 20 cents a share, in the first quarter, and $29 million, or three cents a share, in the second quarter of 2010. The second-quarter results were boosted by a $142 million release of loan loss reserves.

The second-quarter net charge-off ratio was 1.11% and reserves covered 2.57% of total loans as of June 30, suggesting that the reserve releases will continue.

The second-quarter net interest margin was a tax-adjusted 3.19%, compared to 3.17% a year earlier. The second-quarter ROA was 1.15% according to SNL.

Following the earnings release, Guggenheim Securities analyst Jeff Davis reiterated his "Buy" rating and $11 price target for the shares, while increasing his 2011 EPS estimate for KeyCorp by 8 cents to 80 cents, and leaving his 2012 estimate unchanged at 65 cents. The analysts said that the company's capital was "stout," with tangible common equity of 11.3% of risk-weighted assets, and that the shares were "too cheap at 90%" of tangible book value.

The shares trade for 10.2 times the consensus 2012 earnings estimate of 79 cents a share, among analysts polled by FactSet.

Out of 23 analysts covering KeyCorp, four rate the shares a buy, 17 have neutral ratings and two analysts recommend selling the shares.

4. U.S. Bancorp

Shares of U.S. Bancorp ( USB) of Minneapolis closed at $26.06 Friday, down 2% year-to-date.

The company reported strong second-quarter loan growth, as second-quarter commercial and commercial real estate loan originations and commitments totaled $16.1 billion, which was a 41% year-over-year increase.

Second-quarter net income was $1.2 billion, or 60 cents a share, increasing from $1 billion, or 52 cents a share, in the first quarter and $766 million, or 45 cents a share, in the second quarter of 2010. The second-quarter results were boosted by a $175 million release of loan loss reserves. U.S. Bancorp's second-quarter operating ROA of 1.51% was the highest among this group of Midwest banks.

Following USB's second-quarter announcement, Morgan Stanley analyst Betsy Graseck reiterated her neutral rating on the shares, with a $30 price target, saying that the company's numbers indicated "strong loan growth going forward as lines get drawn down."

The shares trade for 9.8 times the consensus 2012 EPS estimate of $2.65, among analysts polled by FactSet.

Out of 25 analysts covering USB, 15 have buy ratings, eight are neutral and two recommend investors sell the shares.

3. Huntington Bancshares

Huntington Bancshares ( HBAN) closed at $6.05, down 12% year-to-date. Based on a quarterly payout of four cents, the shares have a dividend yield of 2.65%. The dividend was increased from a penny, when Huntington announced its second-quarter results.

The company reported second-quarter net income of $145.9 million, or 16 cents a share, compared to $126.4 million, or 14 cents a share in the first quarter and $48.8 million, or three cents a share, in the second quarter of 2010. A $62.1 million release of loan loss reserves provided a large second-quarter earnings boost, and the operating ROA was 1.11%, according to SNL Financial.

Total loans were $38.5 billion as of June 30, increasing 4% from June 2010, with strong growth in commercial and industrial loans, which totaled $13.4 billion and increased 9% year-over-year, and automobile loans, which were up 28% to $6 billion

Credit costs continued to decline, with a second-quarter provision for credit losses of $35.8 million, compared to $49.4 million the previous quarter and $193.4 million a year earlier.

Credit Suisse analyst Craig Siegenthaler has an "Outperform" rating on the shares with an $8.50 price target, which was reduced from $9 after the second-quarter results were announced. Among the positives cited by the analyst was a 32% year-over-year increase in non-interest bearing deposits.

The shares trade for 8.9 times the consensus 2012 earnings estimate of 68 cents a share, among analysts polled by FactSet.

Out of 17 analysts covering Huntington Bancshares, 10 rate the shares a buy, six have neutral ratings and one analyst recommends investors sell the shares.

2. Fifth Third Bancorp

Shares of Fifth Third Bancorp ( FITB) closed at $12.65 Friday, down 13% year-to-date.

second-quarter net income available to common shareholders was $328 million, or 35 cents a share, increasing from to $88 million, or 10 cents a share in the first quarter and $130 million, or 16 cents a share, in the second quarter of 2010. The second-quarter numbers were boosted by a $191 million reserve release, and the operating ROA was 1.21% according to SNL Financial.

Following Fifth Third's second-quarter earnings announcement, Guggenheim Securities analyst Marty Mosby reiterated his "Buy" rating for the shares and $16 price target, saying that "pre-provision profits increased by 2% sequentially," and that "FITB generated an annualized 8% sequential quarter growth in commercial loans."

Mosby went on to point out that Fifth Third "trades at a discount relative to our other super regional banks but is already producing over a 1% return on assets and double-digit return on equity."

The shares trade for 8.6 times the consensus 2012 EPS estimate of $1.47, among analysts polled by FactSet.

Out of 24 analysts covering Fifth Third Bancorp, 14 rate the shares a buy, nine have neutral ratings and one analyst recommends selling.

1. Citizens Republic Bancorp

Shares of Citizens Republic Bancorp ( CRBCD) of Flint, Mich. closed at $9.19, returning 49% year-to-date, which is the only positive return this year, among the 10 Midwest banking names discussed here.

The shares underwent a 1-for-10 reverse split on July 5.

On July 20, Citizens Republic said it had regained compliance with NASDAQ's minimum bid price rule, and that its shares would return to its previous ticker listing of "CRBC" on August 2.

The company also owes $300 million in TARP money, and has deferred its last six quarterly dividend payment to the government.

Citizens Republic reported second-quarter net income applicable to common shareholders of $18.5 million, or 46 cents a share, driven by a $17.8 million release of loan loss reserves and a $10 million income tax benefit. This was the company's first quarterly profit in three years. The results compared to a loss of $74.3 million, or $1.89 a share, the previous quarter and a loss of $44.7 million, or $1.27 a share, a year earlier.

KBW analyst John Barber on July 11 raised his rating for Citizens Republic to "Outperform" with a price target of $13, saying the company had "significantly improved its credit quality and differentiated itself from peers."

The shares trade for 7.7 times the consensus 2012 EPS estimate of $1.20, among analysts polled by FactSet.

Three of the four analysts covering Citizens Republic rate the shares a buy. The remaining analyst has a neutral rating.

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., 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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