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By Beth Piskora Regional banks generally met or exceeded Standard & Poor's earnings estimates for the third quarter, but the strong run-up in stock prices this year means many of these issues appear fully valued. "Going forward, I'm not worried about companies making their numbers," says James O'Brien, a bank analyst at S&P. "But I don't see any potential for upside surprise. We're expecting only high-single-digit growth in per-share earnings. The banks tend to be cautious in their outlooks. But valuations appear very high to us."
Indeed, regional banks are now trading above their historical valuations. According to O'Brien, small-cap banks are trading at about 18 times projected 2004 earnings and 16 times estimated 2005 earnings. In the mid-cap area, they're selling at 16 times estimated 2004 earnings and 15 times projected 2005 profits. "How can you get excited about paying a p-e of 16 for something that's a 9% grower?" O'Brien says.
"MORE BORROWINGS"? That's one reason why S&P recommends only a market weighting for financial-services stocks, which make up about 21% of the S&P 500-stock index. The good news for regional banks, as O'Brien sees it, is that demand for loans from small and midsize businesses is starting to emerge. Also, he's not concerned about any future interest rate hikes by the Federal Reserve.
"Higher interest rates generally signal stronger economic activity, which generally leads to more borrowings by industries," O'Brien says. "Higher rates may signal continued demand for commercial and industrial loans, in the neighborhood of a high-single to low-double-digit rate of growth."
To find the best choices for investors, O'Brien searched for those issues that have relatively low valuations and strong growth prospects. His top pick among smaller- and mid-cap regionals is Commerce Bancorp (CBH
; ranked 5 STARS (buy); recent price: $58.78).
He recommends avoiding the following regional banking stocks because he believes they're fully valued: Fulton Financial (FULT
); 2 STARS (avoid), $21.44), Hibernia Corp. (HIB
; 2 STARS; $29.37), M&T Bank (MTB
), 2 STARS; $105.60), and TCF Financial (TCB
); 2 STARS; $31.45). Each of these stocks trades above his 12-month target price. Piskora is senior editor of Standard & Poor's weekly investing newsletter, The Outlook