My grandfather used to say, though never to me directly, that "banking is like sex. When it's good, it's great. And when it's bad, it's still pretty good."
While the financial crisis may have led the average investor to question this -- 454 banks have been seized by regulators since the beginning of 2008 -- the industry is back on its feet and growing again -- albeit at a less frenetic pace than before. In its most recent quarterly banking profile, for instance, the FDIC noted that the industry's first-quarter aggregate net income of $35.3 billion is the highest it's been since the second quarter of 2007.
Yet many banks are still trading for fractions of book value. While the average savings and loan institution is selling for an 11% discount, mega-money center banks like Bank of America and Citigroup are trading for less than half of their book value. In this environment, it's become exceedingly important for investors in financial stocks to be able to separate the winners from the losers. And to do this appropriately, one must look under the proverbial hood.
In this series, I examine six of the most important metrics to assess the quality of a bank's operations. The current lender under the microscope is Huntington Bancshares (Nasdaq: HBAN ) , a Columbus, Ohio-based commercial bank with $56 billion in assets.
|Tier 1 capital ratio
|| approx. 8%
|Net interest margin
|| >= 3.5%
|Provision for loan losses (as a % of net interest income)
|Net noninterest expense (as a % of net interest income)
|Nonperforming loans (as a % of total loans)
|Return on equity (TTM)
|| >= 15%
Sources: Huntington Bancshares' Q2 2012 10-Q and Yahoo! Finance.
Before analyzing Huntington's otherwise pedestrian statistics, it's helpful to understand how far it's come in the last few years.
During the financial crisis and continuing into 2010, Huntington experienced massive losses, which prompted the federal government to intervene in its operations by means of the Troubled Asset Relief Program. Loan loss provisions swelled from an average of $67 million a year in 2004-2006 to over $1 billion in 2008 and $2 billion in 2009. And in the first quarter of the latter year, the bank also recorded a $2.6 billion goodwill impairment related to an ill-fated acquisition on the eve of the crisis.
Under the stewardship of a new CEO, the bank has since experienced a remarkable turnaround. Its annual provision for loan losses fell to a comparatively modest $174 million in 2011. It repaid its TARP funds at the end of 2010 -- albeit by issuing new common stock. And it's committed itself publically to the fundamental principles of sound banking -- notably, loans and deposits. According to its most recent quarterly filing: "Our general business objectives are: (1) grow net interest income and fee income, (2) increase cross-sell and share-of-wallet across all business segments, (3) improve efficiency ratio, (4) continue to strengthen risk management, including sustained improvement in credit metrics, and (5) maintain strong capital and liquidity positions."
While the bank's second-quarter balance sheet evidences progress in these regards, there's unquestionably still room to go. Most significantly, Huntington's pivotal net interest margin of 3.42% is below the industry average of 3.52%. However, it should be noted that the key in this regard is yield, as its capital allocation appears to be spot-on; loans make up 81% of its interest-bearing assets, and deposits account for 89% of its liabilities -- not to mention, 40% of the latter are demand deposits.
Of more immediate importance is Huntington's income statement. Although its loan loss provisions have declined markedly since 2009, they still consume 8.5% of its otherwise subpar net interest income. Fortunately, improvement here will likely happen as a matter of course, as bad loans work their way through the system over the next few years. But beyond its loan book, Huntington's noninterest expenses are simply too high without an increase in noninterest income to mitigate the impact on the bottom line.
Yet despite these shortcomings, Huntington manages to notch a double-digit return on equity of 10.57%, beating the 9.07% industry average for the first quarter of the year. While this is below my preference of 15% ROE, it's nothing to shake a stick at, and it's unquestionably one of the reasons that Huntington doesn't trade at a lower price-to-book multiple than its current 1.06.
So, is Huntington Bancshares a buy?
All things considered, Huntington looks to me like it's positioned to excel. Its capital ratios are more than adequate. Its loans and deposits are both growing. It seems to be managed by prudent and responsible fiduciaries. And it trades for reasonable premiums to both book value and tangible book value. Assuming it continues on its current trajectory, in turn, I'd say it's a solid addition to any long-term portfolio.
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