Bank M&A story updated with additional information on likely buyers, sellers.

NEW YORK ( TheStreet) -- The case for consolidation in the banking sector remains strong in 2012 as heightened regulatory costs, demands for greater capital, revenue pressures and mounting expenses will force smaller banks to re-evaluate their ability to stay independent.

However, few analysts expect the pace of M&A to really pick up in 2012, as volatility in the markets and macroeconomic uncertainty gives buyers pause, while depressed valuations have made reluctant sellers.

Still, a few deals might be all it takes to get the chatter going and get the market to start attaching higher valuations to likely targets.

Deal activity slowed down in 2011 as the number of FDIC- assisted transactions declined, according to KBW analyst Chris McGratty. On the one hand, bank failures declined with the problem shifting from one of liquidity to one of earnings. Two, as banks have become healthier, there has been more competition for deals, which has meant that the terms of such deals aren't as attractive as they used to be.

Meanwhile, traditional deal activity has not picked up as sellers still pine for the valuations of the old days, which is little more than a "fantasy" on their part, the analyst says.

Instead what the market has seen is banks becoming more creative in the structure of the deals, McGratty says. Banks are picking up only certain assets, for instance.

KBW regularly screens for potential buyers and sellers in the banking space as it believes a "multi-year" consolidation cycle has been set in motion. "Banks are under increasing amount of earnings pressure, regulatory pressure, they are facing higher capital requirements and expenses are going in the wrong direction. The case for consolidation is still strong." he said.

In some markets, consolidation is almost inevitable. "In markets like the MidWest- that is the third largest market but it is still really fragmented. Margins are tighter as competition is cut-throat. That market should consolidate over time," he added.

Sellers are typically likely to be banks with weak capital positions or weak competitive advantages but it could also include those with attractive franchises that could still command a premium. But investors should be careful when it comes to buying into targets with the expectation of upside upon an acquisition.

Small and mid-cap banks are likely to be more active in deals than the large players. Banks like Bank of America ( BAC) are busy shedding assets, not buying them. Even banks with strong capital like JPMorgan Chase ( JPM) are unlikely to participate in acquisitions as they look to build capital in accordance with new regulatory targets.

"Not all sellers will be selling from a place of strength," McGratty cautions. " Some might have severely impacted franchises, might have to go through a forced sale."

He adds that there are targets that could still command a premium but investors need to be more selective,.

McGratty recommends a "barbell" investment strategy to play the M&A opportunity in banking. Investors should buy a handful of likely buyers- those that have the flexibility to deploy capital- and a handful of likely sellers which have a franchise value that can command a premium.

TheStreet pared down KBW's list of about 20 potential targets to five actively stocks with an average 3-month trading volume of more than 500,000. Note that not all these stocks are necessarily on the buy list of KBW. Some potential sellers that have an outperform rating from KBW include Citizens South Banking ( CSBC), Metrocorp Bancshares ( MCBI) and West Coast Bancorp ( WCBO). Trading volumes on these stocks however tend to be thin and hence did not make our list.

Here are five likely regional bank M&A targets, listed in alphabetical order.

5.Boston Private Financial Holdings

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Shares of Boston Private Financial Holdings ( BPFH) is a rare outlier among bank stocks, gaining 19% in 2011 in a year when bank stocks have been deep in the red.

The bank through independently operated affiliates offers investment management and wealth advisory services to high networth investors and institutional clients. It has over $6 billion in assets and $4.5 billion in deposits.

The bank has already been featured in TheStreet's 10 Community Bank M&A Targets.

The bank turned around in the third quarter, posting a net income attributable to common stockholders of $11.4 million, or 14 cents per share, compared with a loss of $7.1 million, or 10 cents per share, a year ago.

Boston Private's operating expenses fell 9 percent to $55.4 million, while its loan loss provision fell 86 percent to $4.5 million.

The bank said in a recent investor presentation that it is investing in private banking franchise building and client acquisition across banking and wealth management businesses.

"Investors are looking for well-balanced bank stocks with solid capital, growing EPS from real revenue expansion, and an attractive franchise that someday could be attractive to a third-party financial institution," FIG Partners analyst Christopher Marinac wrote in an Oct. 27 report.

Still, a sale in 2012 is unlikely, according to KBW analyst Chris McGratty. "The company is in year 2 of its turnaround. It is going very well and the turnaround story has atleast another year of leg to it," he said. The bank figures in KBW's potential sellers list for two reasons- its attractive franchise value and the fact that it has a significant private-equity ownership.

McGratty has an outperform rating on the stock with a price target of $9.

Four analysts rate the stock a buy or outperform, while five have a hold rating on the stock.

4.First Horizon National

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Shares of First Horizon National ( FHN) have lost 36% in value in the year-to-date.

The Memphis, Tennessee-based bank has more than 180 bank branches in and around Tennessee. It has $25.57 billion in assets and $15.69 billion in deposits.

The bank's capital levels are quite solid with a Tier 1 Common Capital ratio of 11.95%.

Recent credit metrics at First Horizon have begun to improve, with the bank reporting nonperforming assets totaling $582.6 million as of Sept. 30, declining 22% quarter over quarter and 37% year over year. The ratio of nonperforming assets to total assets was 3.02% as of Sept. 30, improving from 4.09% the previous quarter and 5% in September 2010.

Still, First Horizon faces a high amount of risk tied to repurchase claims. First Horizon's reps and warrants provision expense more than doubled in the quarter and the company realized $53 million of losses while the pipeline of repurchase requests was $419 million at the end of 3Q11.

"We remain wary regarding First Horizon's relative overexposure to potential reps and warrants losses as its pipeline of requests remains strong at $419 million and losses increased in the quarter," FBR Capital analyst Paul Miller wrote in a report. "Until we gain more clarity into First Horizon's earnings power and its ultimate reps and warrants exposure, we look to remain on the sidelines with regards to shares."

Sterne Agee analyst Todd Hagerman has an underperform or sell rating on the shares, saying on Oct. 19 that " "core revenues remain uninspiring and the outsized benefit from improving credit will likely dissipate as we enter 2012 -- challenging the company's ability to earn its cost of capital. "

16 analysts rate the stock a buy, 12 have a hold rating while 1 analyst has an underperform rating on the stock.

3.Regions Financial

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Shares of Birmingham, Alabama-based Regions Financial ( RF) have shed more than 40% in 2011 year-to-date.

Regions Financial has $129.76 billion in total assets and total deposits of $95.94 billion. It has 1,722 branches across South, Midwest and Texas.

Regions is the among the few big banks yet to redeem TARP money to the government. It has a Basel Tier 1 Capital of 8.2%, which is lower relative to peers. It also has been lagging in the credit recovery cycle with non-performing asset inflows jumping in the third quarter.

Regions might come up short in the Fed's stress test in 2012, according to KBW analysts. The bank is expected to engage in asset sales to improve capital ratios and might even have to raise capital of upto $1.7 billion, KBW said in a recent report. That means investors can forget about dividend increases or buybacks.

Regions Financial CEO told investors at the Goldman Sachs Financial Services Conference that the bank had run its own stress tests and found no surprises in its loan portfolio.

The bank has said it is putting up broker-dealer unit Morgan Keegan for sale but challenging market conditions made the sale more complex and slowed the process.

Only four out of 27 analysts rate the stock a buy or outperform. 20 analysts have a hold rating while 3 have an underperform or sell rating.

2.Synovus Financial

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Shares of Synovus Financial ( SNV) have plunged nearly 50% in 2011.

The bank is headquartered in Columbus, Georgia and has over $28 billion in assets and $23 billion in deposits, with close to 300 branches in Georgia, Alabama, South Carolina, Florida and Tennessee.

Synovus has a Basel 1 Tier 1 Common Capital ratio of 8.5%. The bank is still working through a high amount of problem assets. It has a non-performing assets ratio of 6.39%.

Still, Synovus is among those expected to turn the credit corner . The bank moved into the black in the third quarter, reversing a 12-quarter losing streak, with a net profit of $15 million or 2 cents per share. But that included a securities gain; core earnings remained negative.

Hedge fund manager Tom Brown told TheStreet that he expects Synovus to make money in the fourth quarter .

Still, Synovus is yet to repay $967.9 million in bailout money, with the possible equity raise creating an overhang on the stock.

Six analysts rate the stock a buy or outperform, 20 analysts rate it a hold and 2 analysts rate the stock a sell or underperform.

1.Western Alliance Bancorporation

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Shares of Phoenix, Arizona-based Western Alliance Bancorporation ( WAL) are down about 20% in 2011.

The bank operates over 40 bank branches in Arizona, California and Nevada. It has about $6.54 billion in total assets and $5.63 billion in total deposits.

The bank has a Tier 1 Common Capital ratio of 8.6% . The bank has repaid the $140 million in bailout money and has also repurchased warrants held by the U.S. Treasury.

WAL experienced strong loan growth of nearly 3% in the third quarter. Total operating revenues increased just 0.5% sequentially but together with a 13% drop in expenses the efficiency ratio improved to 63.2% from 72.9%. The drop was attributable to a decline in foreclosure-related writedowns/losses, which could tick up again if conditions worsen in Nevada, which has 40% of the company's total loans.

Non- performing assets rose 1% to $200.4 million or 4.34% of loans in the third quarter. Net charge-offs amounted to 1.4% of loans.

"While we recognize the lingering concerns about the credit exposure to troubled markets like Nevada and Arizona, ultimately we believe WAL shares could earn back a premium multiple given the company's strong shareholder-driven management team and its prospects for taking market share and delivering above-average growth over time," RBC Capital analysts wrote in a Oct.18 report following the results.

KBW analysts rate the stock a market perform with a price target of $7.50.

Seven analysts rate the stock a buy or outperform while seven others rate it a hold.

>>To see these stocks in action, visit the 5 Bank Stocks That Could Jump on 2012 M&A portfolio on Stockpickr.

--Written by Shanthi Bharatwaj in New York

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