Midwest Banks vs. Northeast Banks: Here Are Winners in Each Region

NEW YORK ( TheStreet) -- The Midwest and Northeast couldn't be more different. And the same goes for their banks. For financial-services investors, zip code may be as important as earnings per share.

The banking industry is still in recovery mode, with the KBW Bank Index ( I:BKX) rising 8% this year through Tuesday's close at 55.46, following last year's 30% return. The index is heavily weighted to the "big four" U.S. banks, including Bank of America ( BAC), Citigroup ( C), JPMorgan Chase ( JPM) and Wells Fargo ( WFC).

While the biggest banks still trade at attractive price-to-earnings multiples, they also have the most "headline risk," as we saw last year when JPMorgan Chase surprised investors with its "London Whale" hedge trading loss. Shares of Bank of America are volatile as the company makes moves to settle investors' mortgage repurchase demands, appease regulators and otherwise put the credit crisis and a history of expensive ill-timed acquisitions behind it.

For investors with long-term horizons looking to move away from banks with regulatory targets on their backs, different regions of the country call for different approaches for picking stocks.

In the Midwest, the major focus is on banks' credit leverage as the economy improves. Large regional players including Huntington Bancshares ( HBAN) of Columbus, Ohio, have continued to stress the importance of the manufacturing recovery, driven by increased car sales. There have been other encouraging comments pointing to an acceleration of economic growth in the region.

"People in the Pacific Northwest are very bullish on Seattle, which is encouraging," according to FIG Partners analyst John Rodis. "Historically, you see the coast get stronger, and then it moves inward to the Midwest."

Sterne Agee analyst Peyton Green says "banks in the Midwest have done better over the past year, with improved credit." Improving loan quality, combined with the gradual clearing out of problem loans and repossessed assets, means lower costs and, for many banks, an earnings boost from the release of loan loss reserves. "One of my favorite Midwest picks is in many respects a recovery play," Green says.

The next step for Midwest banks is to focus on loan growth, but "growth is hard to come by," according to Green.

Sterne Agee analyst Matthew Kelley says that in the Northeast, "we are continuing to see smaller community banks take more market share from the big players. This is a much larger theme in the Northeast than in other markets."

According to Kelley, large banks losing market share to more nimble local competitors include Bank of America, TD Bank ( TD) and Sovereign Bank, which is held by Banco Santander SA ( SAN).

Green says investors are looking at "a regular-world frame work," with merger deals providing "much of a catalyst" for shares. "Bank stocks in the Northeast have not had much of a credit cycle to go through. The residential real estate bust was pretty much a nonfactor in the Northeast."

An example of a Northeast bank that has sailed through the credit crisis with robust loan growth and investor returns is Signature Bank ( SBNY), which Green says "has had an incredible four-year run."

Sterne Agee has provided three "top ideas" among community bank stocks in the Midwest -- with one seconded by Rodis -- and another three buy-rated picks among Northeast names. There are different themes among the group, including credit recovery, expansion through acquisitions, loan growth, and a conversion from mutual to full-stock ownership.

Here are the six Midwest and Northeast community bank-stock picks, grouped by region:

Lakeland Financial


Shares of Lakeland Financial ( LKFN) of Warsaw, Ind., closed at $25.05 Tuesday, down 3% this year, following a 3% return during 2012.

The shares trade for 1.4 times tangible book value, according to Thomson Reuters Bank insight, and for 11.1 times the consensus 2014 EPS estimate of $2.26, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is $2.19.

Based on a quarterly payout of $0.17, the shares have a dividend yield of 2.72%.

Lakeland Financial had $3.1 billion in total assets as of Dec. 31. The company reported fourth-quarter earnings of $8.6 million, or $0.52 a share, declining from $9.3 million, or $0.57 a share, in the third quarter, but increasing from $8.3 million, or $0.50 a share, in the fourth quarter of 2011. The sequential earnings decline reflected a $1.25 million provision for loan losses during the fourth quarter, after the company made no provision the previous quarter.

Fourth-quarter net interest income declined to $20.9 million from $22.2 million the previous quarter, and $22.8 million a year earlier, reflecting a narrowing of the net interest margin (NIM) to 3.10% from 3.30% in the third quarter and 3.38% during the fourth quarter of 2011.

The net interest margin is the difference between the average yield on loans and investments and the average cost for deposits and borrowings. With the Federal Reserve keeping the short-term federal funds rate in a range of zero to 0.25% since the end of 2008, most banks are seeing a portion of their assets reprice at lower rates, while already realizing most of the benefit of lower funding costs.

But the yield curve has been widening a bit lately, with the market yield on 10-year U.S. Treasury bonds rising to roughly 2% at the end of January, and staying there ever since. The 10-year was trading at yields of between 1.58% and 1.78% in November.

Lakeland's operating return on average assets (ROA) was 1.19% during 2012 according to Thomson Reuters Bank Insight, which was the strongest ROA among the six banks being discussed here.

When discussing Lakeland's stock returns, Rodis says "part of last year's underperformance was that they didn't show loan growth," but he likes Lakeland's focus on steering clear of acquisitions and focusing on internal loan growth. "They are taking market share from the bigger banks in the market."

Rodis said in a report on Jan. 28 that fourth-quarter "loan growth was better than expected with the portfolio increasing 2.5% linked-quarter. The loan growth was driven by commercial related credits and by region included some solid gains in the Indianapolis market." The analyst expects "mid-single-digit growth going forward" for the loan portfolio.

Rodis rates Lakeland Financial "outperform," with a price target of $29, and estimates the company will earn $2.14 a share this year, with EPS growing to $2.30 in 2014.

Sterne Agee analyst Kenneth James has a $30 price target for Lakeland, estimating the company will earn $2.20 a share in 2013, with EPS of $2.37 in 2014. James said in a report on Jan. 28 that "with the NIM near a bottom, loan growth picking up and expectations lowered, the entry point and risk/reward for this solid bank appear very attractive."

LKFN Chart LKFN data by YCharts

Interested in more on Lakeland Financial? See TheStreet Ratings' report card for this stock.

Old National Bancorp


Shares of Old National Bancorp ( ONB) of Evansville, Ind., closed at $13.92 Tuesday, returning 17% this year after a 5% gain during 2012.

The shares trade for 1.2 times tangible book value, and for 12.3 times the consensus 2014 EPS estimate of $1.13. The consensus 2013 EPS estimate is $1.07.

Based on a quarterly payout of $0.10, the shares have a dividend yield of 2.87%.

Old National had $9.5 billion in total assets as of Dec 31. The balance sheet grew by 7% from a year earlier, mainly reflecting the acquisition of Indiana Community Bancorp in September.

The company reported fourth-quarter earnings of $23 million, or $0.23 a share, increasing from $19.7 million, or $0.20 a share, the previous quarter, and $22.2 million, or $0.23 a share, a year earlier. The company's net interest income totaled $84 million in the fourth-quarter, increasing from $74.1 million in the third quarter, and $76 million in the fourth quarter of 2011.

Net interest income increased significantly from the Indiana Community acquisition, as well as "accretion of purchase accounting discounts" related to the purchase of two failed banks from the Federal Deposit Insurance Corp.

Noninterest expenses rose significantly to $99.4 million in the fourth quarter from $89 million the previous quarter, and $93.7 million a year earlier. The company said fourth-quarter expenses were boosted by $2 million in expenses related to the Indiana Community acquisition, as well as "$2.6 million in branch optimization expense, $1.9 million for the extinguishment of debt," and a $1 million charitable contribution.

The company's 2012 ROA was 1.03%.

Sterne Agee analyst Kenneth James has a $15 price target for Old National, estimating the company will earn $1.08 a share this year, with EPS rising to $1.17 in 2014. The analyst said in a report in December that the stock was a good defensive play because of "better-than-average revenue diversification with 38% from non-interest sources including insurance brokerage and wealth management operations."

ONB Chart ONB data by YCharts

Interested in more on Old National Bancorp? See TheStreet Ratings' report card for this stock.

TCF Financial


TCF Financial ( TCB) of Wayzata, Minn., closed at $13.78 Tuesday, returning 14% this year, following a 20% increase in 2012.

The shares trade for 1.6 times tangible book value, and for 11.8 times the consensus 2014 EPS estimate of $1.17. The consensus 2013 EPS estimate is $0.94.

Based on a quarterly payout of $0.05, the shares have a dividend yield of 1.45%.

TCF had $18.2 billion in total assets as of Dec. 31. The company reported fourth-quarter earnings of $23.6 million, or $0.15 a share, increasing from $9.3 million, or $0.06 a share during the third quarter, and $16.4 million, or $0.10 a share, during the fourth quarter of 2011. During the most recent quarter, the company paid a $10 million civil fine for "deficiencies" in its Bank Secrecy Act compliance program.

The earnings improvement reflected a decline in credit expenses. The fourth-quarter provision for loan losses was $48.5 million, declining from $96.3 million the previous quarter and $59.2 million a year earlier. During the third quarter, TCF the provision was boosted by $31.5 million because of regulatory guidance requiring "requiring loans subject to a borrower's discharge from personal liability following Chapter 7 bankruptcy, to be reported as non-accrual loans, and written down to the estimated collateral value, regardless of delinquency status."

Total nonperforming assets -- including nonaccrual loans, repossessed real estate and the "loans discharged in bankruptcy" that the company was required to begin treating as nonaccrual loans during the third quarter -- totaled $476.4 million as of Dec. 31, declining from $542.2 million in September.

TCF's ROA during 2012 was a negative 1.18%, as TCF during the first quarter of last year booked a net loss of $292.9 million, or $1.78 a share, after the company repositioned its balance sheet by prepaying long-term borrowings and selling lower-yielding mortgage-backed securities.

Green calls TCF a "credit recovery play, with decent loan growth in the upper single digits."

The company has lagged behind many other Midwest banks in the credit recovery, because of a "much more significant mix of residential loans on the balance sheet," and the clearing out of the problem residential loans has been slow "because of foreclosure moratoriums and things like that," according to Green.

The analyst's price target for TCF's shares is $14, and he said in a report on Jan. 31 that "much more progress on the credit quality should drive an improvement in EPS to $1.00 in 2013E and $1.40 in 2014E."

TCB Chart TCB data by YCharts

Interested in more on TCF Financial? See TheStreet Ratings' report card for this stock.

Berkshire Hills Bancorp


Shares of Berkshire Hills Bancorp ( BHLB) of Pittsfield, Mass., closed at $24.68 Tuesday, returning 4% year-to-date, after an 11% return last year.

The shares trade for 1.6 times tangible book value, and for 10.4 times the consensus 2014 EPS estimate of $2.38. The consensus 2013 EPS estimate is $2.28.

Based on a quarterly payout of $0.18, the shares have a dividend yield of 2.92%.

Berkshire Hills had $5.3 billion in total assets as of Dec. 31. The company acquired Beacon Federal Bancorp of East Syracuse, N.Y., in October, adding about $1 billion in assets, along with seven offices.

The company reported fourth-quarter earnings of $9.3 million, or $0.38 a share, declining from $10 million, or $0.46 a share, in the third quarter, and increasing from $8.5 million, or $0.40 a share, in the fourth quarter of 2011. Fourth-quarter net interest income increased to $42 million from $35.2 million the previous quarter, and $31.1 million, reflecting Beacon Federal and other acquisitions. The fourth-quarter results also included $4.5 million in nonrecurring merger related expenses.

The company's 2012 ROA was 0.76%.

Berkshire Hills on Feb. 7 announced plans to expand its commercial lending team in eastern Massachusetts, "to service middle-market commercial and industrial businesses." The new lending group is to be headed by a former commercial lending team leader at TD Bank, perfectly illustrating how smaller community banks can take market share from larger rivals.

Kelley says that there are still "big market-share taking opportunities for Berkshire Hills Bancorp.

The analyst said in a report on Jan. 29 that "loans unexpectedly declined by 3% (11% annualized)" during the fourth-quarter as the company purposely allowed residential loans to runoff and experienced higher prepayments on acquired commercial real estate loans than expected. However, Kelley expects that "loans will grow by 7.2% and 7.5% in 2013 and 2014."

Kelley's price target for Berkshire Hills Bancorp is $26.00 and he estimates the company will earn $2.26 a share this year, with earnings increasing to $2.30 a share in 2014.

BHLB Chart BHLB data by YCharts

Interested in more on Berkshire Hills Bancorp? See TheStreet Ratings' report card for this stock.

Investors Bancorp


Shares of Investors Bancorp ( ISBC) of Short Hills, N.J., closed at $18.40 Tuesday, returning 4% year-to-date after a 32% advance in 2012.

The shares trade for 2.1 times tangible book value, and for 18.8 times the consensus 2014 EPS estimate of $0.98. The consensus 2013 EPS estimate is $0.86.

Based on a quarterly payout of $0.05, the shares have a dividend yield of 1.09%.

Investors Bancorp had $12.7 billion in total assets as of Dec. 31, with assets growing 19% from a year earlier, reflecting in part the acquisition of Brooklyn Federal Bancorp in January 2012 and Marathon National Bank of New York in October.

The company reported fourth-quarter net income of $21.4 million, or $0.20 a share, declining from $24.5 million, or $0.23 a share, in the third quarter, but increasing slightly from $21.1 million, or $0.20, in the fourth quarter of 2011. Results in the most recent quarter included one-time acquisition-related expenses of $4.4 million, after tax.

Fourth-quarter net interest income was $101.5 million, increasing from $91.9 million the previous quarter, and $84.8 million a year earlier. The increase in net interest income of course reflected the acquisition of Marathon National Bank, but also reflected a widening of the net interest margin.

The fourth-quarter net interest margin was 3.51%, expanding from 3.35% in the third quarter and 3.36% in the fourth quarter of 2011. Kelley said in a report on Feb. 1 that "the core margin expanded by 12 bp sequentially to 3.39% and prepayment penalty income was double what we had been expecting (12 bp margin impact vs. 6 bp estimate)."

The company's 2012 ROA was 0.77%.

Kelley says that Investors Bancorp "has now rolled-up six transactions that have expanded their presence in the New York and New Jersey marketplace in a very affordable manner." The analyst also expects the acquisitions to continue.

Investors Bancorp is part of a mutual holding company structure, with Investors Bancorp MHC holding 58.4% of the common shares as of Sept. 30. Kelley said in a report on Feb. 1 that he expected the company to undergo a second-step conversion to full stock ownership in the second half of 2013. "In our view, the company can complete a deal in the 96%-100% of tangible book value, or TBV range. Based on year end 2013 balance sheet estimates, this would produce fully converted TBV's in current terms of $18.44-$19.30 per share."

Kelley's price target for Investors Bancorp is $20 and he estimates the company will earn $0.90 a share this year, with EPS increasing to $0.92 in 2014.

ISBC Chart ISBC data by YCharts

Interested in more on Investors Bancorp? See TheStreet Ratings' report card for this stock.

Northfield Bancorp


Shares of Northfield Bancorp ( NFBK) of Avenel, N.J., closed at $11.45 Tuesday, returning 6% this year after an 8.5% gain last year.

The shares trade for 0.9 times tangible book value according to Sterne Agee's estimate, and for 45.8 times the consensus 2014 EPS estimate of $0.25. The consensus 2013 EPS estimate is $0.23.

Northfield Bancorp had $2.8 billion in total assets as of Dec. 31. The company in November acquired Flatbush Federal Bancorp of Brooklyn, bringing on $131.5 million in assets and three branches.

The company on Jan. 22 completed a second-step conversion to full stock ownership, raising $356 million through a direct offering to depositors and through the community. The new shares were sold at a price of $10.00. In order for minority shareholders to preserve their ownership percentage, they were granted 1.4029 in new shares for each of their old shares.

Northfield reported fourth-quarter $3.2 million, or $0.06 a share, declining from $3.8 million, or $0.07 a share, a year earlier. The results for the fourth quarter of 2011 reflected a $3.6 million after-tax bargain purchase gain. With credit quality improving, the company's fourth-quarter provision for loan losses was $1.9 million, declining from $7.5 million a year earlier.

Kelley says that after a one-year moratorium on share repurchases following the conversion, "they will be in capital return mode in the next couple of years, growing organically and buying back stock."

Sterne Agee analyst Matthew Breese initiated his firm's coverage of Northfield Bancorp in a report on Jan. 23, with a price target of $18.00, equating to "a 106% price-to-tangible book value ratio, adjusted for the acquisition of Flatbush Federal and the company's second step conversion." Adjusting for a share conversion ratio of 1.4029, the analyst's estimate of Northfield's tangible book value is $12.10 a share, and his price target for the shares is $12.83.

"In-market, former mutual peers currently trade at an average price-to-tangible book value multiple of 105% versus Northfield trading at 91%," Breese wrote. "Given the company's outlook for growth and profitability, we believe shares will trade more in line with peers over the next 12-18 months."

Breese also said that "first-year returns for conversions are the highest due to steep valuation discounts in the offering and investors driving share prices higher in anticipation of share repurchases. Looking ahead, we believe Northfield's performance will track similarly to peers as it is revalued as a fully public entity and begins repurchasing stock post its one-year anniversary."

The analyst said that for 35 second-step conversions completed since 2002, with gross proceeds of over $50 million, the median first-year total return was 17%, while the mean total return was 12%.

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

NFBK Chart NFBK data by YCharts

Interested in more on Northfield Bancorp? See TheStreet Ratings' report card for this stock.

>Contact by Email.

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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