5 Rational Bank Stock Picks for an Irrational Market

NEW YORK ( TheStreet) -- As we continue to highlight defensive bank plays for investors, TheStreet has identified five bank holding companies that have achieved strong, consistent earnings results through thick and thin.

These names have pulled back along with the rest of the banking sector, although the case can be made that the pullback for this group is simply irrational. Then again, an irrational market sets up good plays for investors.

While at this point in the credit cycle many banks are seeing significant boosts to earnings as their credit quality improves and they release loan loss reserves, there are banks out there that have managed to continue posting excellent results, quarter after quarter.

Beginning with a list of all publicly traded U.S. bank and thrift holding companies - except for those traded on the Pink Sheets -- we excluding companies whose return on average assets (ROA) dipped below 1% in any of the past 10 quarters, according to SNL Financial. That left us with 16 holding companies, and we narrowed down the list to the five with the highest average trading volume over the past three months.

For the ROA calculation, we went with net income before extraordinary items as a percentage of average assets.

Why focus on ROA? During the "good times" for the banking industry, investors have a tendency to focus on return on average equity (ROE), and while this can make sense "all things being equal," all things are not equal.

A high ROE could mean that a company isn't strongly capitalized. Another problem with ROE is that the figures for banks that have been boosting their capital levels through the credit crisis have become distorted.

An honorable mention goes to First Republic Bank ( FRC) of San Francisco, which was spun-off from Bank of America ( BAC) in 2010, after being acquired along with Merrill Lynch in 2009. According to SNL Financial, First Republic's ROA has exceeded 1.20% since the third quarter of 2009, which is as far back as the data is available.

A second honorable mention goes to Westamerica Bancorporation ( WABC), which didn't make the group of five because of lower trading volume. The company has achieved an ROA exceeding 1% since the fourth quarter of 2008. Westamerica's second-quarter ROA was 1.73%.

Here are the five actively traded bank holding companies that have posted good -- or better -- earnings results for the past 11 quarters, in descending order by price-to-forward-earnings ratios. Three out of five are headquartered in Texas.

5. First Financial Bankshares

First Financial Bankshares ( FFIN) of Abilene, Texas, has seen its stock decline 15% year-to-date, closing at $28.59 Tuesday. Based on a quarterly payout of 24 cents, the shares have a dividend yield of 3.36%.

The company's ROA was 1.74% during the second quarter, and has ranged from 1.58% to 1.82% over the past 10 quarters, according to data supplied by SNL Financial.

Second-quarter earnings were $16.5 million, or 52 cents a share, increasing from $14.2 million, or 45 cents a share, during the second quarter of 2010. Net interest income increased 14% year-over-year to $38.2 million, as the company grew its loan portfolio by 13%. The second-quarter provision for loan losses declined to $1.9 million from $3.0 million a year earlier.

The second-quarter net interest margin -- the difference between a bank's average yield on loans and investments and its average cost for deposits and wholesale borrowings -- was a very healthy 4.69%, increasing slightly from a year earlier.

The shares trade for 2.2 times tangible book value, according to SNL Financial, and 12.4 times the consensus 2012 earnings estimate of $2.21 a share, among analysts polled by FactSet.

All eight analysts covering First Financial Bankshares have neutral ratings on the stock, which they may wish to revisit.

Following the second-quarter earnings announcement, Sterne Agee analyst Brett Rabatin on July 25 reiterated his neutral rating for First Financial, suggesting investors "buy this top institution on pullbacks." Well, the shares have pulled back 14% since then.

While First Financial may look expensive compared to bargain-priced banks facing worlds of trouble, you get what you pay for, and this is a name well-suited for investors who can remain committed long enough to reap the rewards of solid, consistent earnings.

4. Bank of the Ozarks

Shares of Bank of the Ozarks ( OZRK) of Little Rock, Ark., closed at $22.05 Tuesday, rising 3% year-to-date. Based on a quarterly payout of 10 cents, the shares have a dividend yield of 1.72%.

The bank's ROA was 5.22% during the second quarter, when it booked bargain purchase gains on two failed banks it acquired from the Federal Deposit Insurance Corp. The ROA has exceeded 1.25% over the past 10 quarters. , and has ranged from 1.58% to 1.82% over the past 10 quarters, according to data supplied by SNL Financial.

The bank had $4 billion in total assets as of June 30, increasing 40% from a year earlier, with the purchase of six failed institutions from the FDIC, including Woodlands Bank of Bluffton, S.C., last July; Horizon Bank of Bradenton, Fla., in September; Chestatee State Bank of Dawsonville, Ga., in December; Oglethorpe Bank of Brunswick, Ga., in January; and Georgia lenders First Choice Community Bank of Dallas and The Park Avenue Bank of Valdosta, both on April 29.

Bank of the Ozarks reported second-quarter net income available to common shareholders of $50.2 million, or $2.91 cents a share, increasing from $10.9 million, or 64 cents a share, in the second quarter of 2010. During the second quarter of this year, the bank booked $36.4 million in after-tax gains on the two failed-bank acquisitions from April 29.

Brian Martin of FIG Partners on July 15 reiterated his "Market-Perform" or neutral rating for the shares, saying that the bank's "tangible book has now more than doubled since the onset of the credit cycle and is slated to grow another $1.40 and $4.50 by 4Q11 and 4Q12, respectively," adding that the book value projections were conservative, since they took no further FDIC acquisitions into account.

Martin maintained his neutral rating, saying that Bank of the Ozarks was "trading at a premium to peers given its strong earnings power, enviable capital position, manageable credit issues and ability to execute on FDIC assisted deals."

The shares trade for 12.2 times the consensus 2012 EPS estimate of $1.76.

Out of nine analysts covering Bank of the Ozarks, one rates the shares a buy, while the remaining analysts all have neutral ratings.

3. Bank of Hawaii

Shares of Bank of Hawaii ( BOH) of Honolulu closed at $39.72 Tuesday, declining 14% year-to-date. Based on a quarterly payout of 45 cents, the shares have an attractive dividend yield of 4.53%.

The bank's ROA was 1.08% during the second quarter, and has ranged as high as 1.70% over the past 10 quarters.

Second-quarter net income was $35.1 million, or 74 cents a share, declining from $46.6 million, or 96 cents a share, in the second quarter of 2010. The earnings decline mainly reflected what the bank called a "one time" $9 million settlement of a class action lawsuit over checking account overdraft fees.

The second-quarter net interest margin was 3.16%, declining from 3.24% a year earlier.

Following the second-quarter earnings release, Brett Rabatin of Sterne Agee reiterated his neutral rating for Bank of Hawaii, saying that although "BOH is a high-quality company, we have not expected the shares to have significant near-term upside given revenue trends and a valuation in-line to slightly above high-quality peers. The analyst said he expected the shares to "be a trading range in the mid-$40s," but added that the dividend "and track record should result in limited downside."

The shares trade for 11.3 times the consensus 2012 EPS estimate of $3.36, among analysts polled by FactSet.

Out of 14 analysts covering Bank of Hawaii, Five rate the shares a buy, seven have neutral ratings and two analysts recommend selling the shares.

2. Prosperity Bancshares

Prosperity Bancshares ( PRSP) of Houston saw its stock decline 8% year-to-date through Tuesday's close at $35.90. Based on a quarterly payout of 18 cents, the shares have a dividend yield of 1.95%.

The company's ROA was 1.45% during the second quarter, for its best earnings performance over the past 10 quarters. The lowest ROA during the period was 1.15% in the first quarter of 2009.

Second-quarter net income was $35.1 million, or 75 cents a share, increasing from $31.7 million, or 68 cents a share, in the second quarter of 2010. Net interest income increased 4% year-over-year to $83.6 million in the second quarter. The provision for loan losses declined to $1.4 million in the second quarter, from $3.3 million a year earlier.

The second-quarter net interest margin was 4.06%, increasing from 4.00% a year earlier. Total loans grew 7% year-over-year to $3.7 billion as of June 30.

Following Prosperity's second-quarter earnings announcement, Brett Rabatin of Sterne Agee on July 22 reiterated his neutral rating for the shares, calling the company "a solid longer-term holding in Texas given the likelihood of continued high profitability and improved loan growth over the next 18-24 months." The analyst said that "Absent higher visibility of acquisition activity increasing in Texas, we suggest looking at the shares on pullbacks."

The shares have pulled back 21% since July 22.

The shares trade for 10.8 times the consensus 2012 EPS estimate of $3.17, among analysts polled by FactSet.

Three out of 17 analysts covering Prosperity Bancshares rate the stock a buy. The remaining analysts all have neutral ratings.

1. International Bancshares

International Bancshares ( IBOC) of Laredo, Texas, has seen its stock slide 27% year-to-date through Tuesday's closing price of $14.52. Based on a quarterly payout of 10 cents, the shares have a dividend yield of 2.62%.

The company's ROA for the second quarter was 1.09%, and has ranged from 1.01% to 1.28% over the past 10 quarters.

International Bancshares owes $216 million in federal bailout funds received through the Troubled Assets Relief Program, or TARP.

The company had $11.8 billion in total assets as of June 30. Second-quarter net income available to common shareholders was $29.3 million, or 43 cents a share, declining slightly from $30.7 million, or 45 cents a share, during the second quarter of 2010.

During the second quarter, the company transferred $1.9 million from loan loss reserves, compared to a $1.4 million provision for reserves a year earlier.

The main factor in the earnings decline was an increase in expenses on foreclosed properties to $8.2 million during the second quarter, from $905 thousand a year earlier.

The shares were trading on Tuesday for just 0.9 times their tangible book value of $15.63, according to SNL Financial, illustrating the TARP overhang.

Sterne Agee analyst Brett Rabatin on August 17 reiterated his neutral rating on International Bancshares, while trimming his 2012 earnings estimate by a penny to $1.64 a share, and estimating the company would earn $1.87 a share in 2013. The estimates assume "TARP repayment in the second half of 2012 without a capital raise."

The analyst views the company "as being a solid defensive holding with limited downside," but added that "the relative outlook for meaningful appreciation is reduced for IBOC given overall reduced valuations for the industry, and particularly for banks with less visibility of stability/improvement in profitability."

The shares trade for 8.9 times Rabatin's 2012 earnings estimate.

So it would appear that International Bancshares may be flying under the radar, which could keep investors from enjoying a quick gain on a sector recovery. The unpaid TARP money is also a drag on the shares, although that is somewhat mitigated by the discount to tangible book value.

For investors with longer horizons, the company's consistent earnings performance speaks for itself, and continued profits and a build in capital should eventually translate into rewards for shareholders.

RELATED STORIES:



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

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

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.

To submit a news tip, send an email to: tips@thestreet.com.

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.

More from Opinion

Tuesday Turnaround: Don't Netflix and Chill Just Yet

Tuesday Turnaround: Don't Netflix and Chill Just Yet

Netflix Reports Earnings on Tuesday: 7 Key Things to Watch For

Netflix Reports Earnings on Tuesday: 7 Key Things to Watch For

Monday Madness: Is Nvidia a Hit or Miss?

Monday Madness: Is Nvidia a Hit or Miss?

From Catalogs to Catastrophe: A Sears Timeline

From Catalogs to Catastrophe: A Sears Timeline

Flashback Friday: Is Sears Bankrupt Yet?

Flashback Friday: Is Sears Bankrupt Yet?