It's a Wonderful Bank

11/25/2010 1:03 pm EST

Focus: STOCKS

Richard Band

Editor, Profitable Investing

Richard Band, editor of Profitable Investing, recommends a regional lender with rock-solid financials and a heady yield thanks to prudent practices and opportunistic acquisitions.

Bankers are wearing a lot of egg on their faces. First came the housing bust, which ravaged bank profits and drove some of America's largest financial institutions to the brink of insolvency. Massive dividend cuts followed, together with steep share-price declines.

The worst of the storm passed in March 2009. For a time, bank stocks rallied sharply, giving investors a renewed sense of hope. Since April, though, bank shares have lagged the market indexes. As we speak, the KBW bank index is languishing more than 20% below its 2010 peak.

Cheap for Good Reasons
What's ailing bank stocks? The worries are manifold:

  • The US economic recovery is proceeding slowly and haltingly, keeping the industry's loan losses unusually high.
  • New government regulations associated with the Dodd-Frank financial reform will cost banks dearly, perhaps $20 billion a year or more.
  • Some of the industry's big players have even managed to shoot themselves in the foot again by ramming foreclosures through the legal system without adequate paperwork.

If all this muck has you throwing up your hands in disgust, I understand. I certainly hold no brief for crooked or incompetent bankers. On the other hand, nearly four decades of investment experience has taught me that when an entire industry is as disliked as banking is now, there are bargains to be had.

Indeed, the beauty of a wipeout like the one we've seen in banking is that you can now buy the best-quality franchises for much less than it would have cost to snag mediocre merchandise three or four years ago.

But you've got to be extremely selective. About 98% of the bank stocks out there don't interest me at all. Let me tell you about one that does.

Majestic Niagara
First Niagara Financial Group (Nasdaq: FNFG) is a regional gem headquartered in Buffalo, NY. While other banks were plunging into subprime mortgages a few years back, First Niagara stuck to its credit standards. As an added precaution, CEO John Koelmel maintained huge amounts of excess capital on the bank's balance sheet-a stance that paid off handsomely when the global financial crisis struck in 2008.

FNFG was in a perfect position to take advantage of the turmoil by gobbling up assets other banks were forced to sell. In 2009, First Niagara acquired Harleysville National, a Pennsylvania bank, as well as 57 western Pennsylvania branches of Cleveland's National City Corp. Both transactions immediately boosted FNFG's earnings per share.

More recently, in August, FNFG inked a deal to take over NewAlliance Bancshares, a healthy Connecticut banking chain. Result: FNFG will have grown from $8 billion in assets to $30 billion in just three years, while paying one-third to one-half the price (in terms of book value) that managements gleefully paid during the heyday for bank takeovers in the late 1990s. First Niagara hasn't compromised its strong credit quality, either. Nonperforming loans at June 30 equaled only 0.74% of the total loan portfolio-versus 5.36% for banks nationally.

Unlike many banks, too, FNFG has continued to pay its dividend at the full pre-crisis rate. Current yield: 4.8%. At 12 times estimated year-ahead earnings, I figure the stock has room to generate a total return of 15% to 20% in the next 12 months.

First Niagara is my pick for conservative investors who want a hearty dividend up front. Buy FNFG at $12 or less. [Shares closed at $12.29 Tuesday-Editor.]

[George Putnam III recommended another Midwest banking bargain earlier this month, while Paul Larson opted for a big national player. Former FDIC chairman and author William Isaac recently discussed the industry's problems in a video interview-Editor.]

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