Zacks Industry Rank Analysis Highlights: Discover Financial, Sallie Mae, Heartland Financial, Metro Bancorp and Encore Bancshares

CHICAGO, Aug. 18, 2011 /PRNewswire/ -- Stocks featured in this week's Zacks Industry Rank analysis include Discover Financial (NYSE: DFS), Sallie Mae (NYSE: SLM), Heartland Financial (Nasdaq: HTLF) and Metro Bancorp (Nasdaq: METR) and Encore Bancshares (Nasdaq: EBTX).

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Zacks Industry Rank Analysis is written by Dirk Van Dijk, CFA, Chief Equity Strategist, Zacks.com.

Money in the Bank

The vast majority of the Regional Banks with Zacks #1 and #2 Ranks are very small firms; only two could plausibly be called large caps -- Discover Financial (NYSE: DFS) and SLM Corp, aka Sallie Mae (NYSE: SLM) -- and even they are more like mid-caps. Only eleven others on the two lists even break the $1 billion market cap level.

On the other hand, twenty nine of them don't even break the $100 million market-cap level. That does not however mean that they can't be good investments. This is a case, though, where you might want to take a package approach -- buying five or six small positions rather than one or two large ones.

The valuations are all over the lot, but for the most part reasonable. Particularly if you are willing to look out to 2012 earnings. 

One Thing to Keep in Mind

The biggest concern among the smaller banks has been the quality of the loans that they have made in the past. In bad economic times, people tend to default on their loans much more frequently than in good times. Many of the smaller banks have been very exposed to the real estate sector as well as to the consumer.

Recently, though, the consumer credit picture has been improving as delinquencies have dropped. They are still at very high levels, but are at least moving in the right direction.

Meanwhile, the basic business of a bank is to borrow money cheaply, mostly in the form of deposits, and then to lend it out at higher rates. The Fed has made clear that it is going to keep the interest rates that banks borrow at extremely low until at least the middle of 2012. The interest rates that consumers pay have come down as well, but not by as much.

The banks then have to be able to collect what they are owed on the higher interest rate loans. That has been a huge concern over the last few years, but it looks like many of the smaller banks have made significant progress in working their way through the piles of bad debt. The lower loan loss provisions and write-offs have lead to some HUGE earnings estimate increase for both this year and next.

A Final Caveat

Most of these small firms are only covered by a handful of analysts. Thus, we might not see quite as many continued estimate increases as we do with better followed firms. One of the big reasons that an estimate in motion tends to stay in motion is that not all the analysts raise their numbers at the same time, and analysts playing "catch up" help the mean estimate to continue to rise.

That is less likely to be the case if there are just one or two analysts following the firm. Still, increases of over 50% for firms like Heartland Financial (Nasdaq: HTLF), Metro Bancorp (Nasdaq: METR) and Encore Bancshares (Nasdaq: EBTX) are nothing to be sneered at, particularly when they are matched with large increases for next year as well.

If you are looking to put a bank in your portfolio, it might be a good idea to think small. These small banks, many with just a handful of branches, are not likely to be heavily exposed to things like bad European Sovereign Debt. If the bad domestic debt is being worked through, then the generosity of the Fed's easy money policies should make the smaller banks very profitable.

It is also very likely that many of these smaller banks could be gobbled up by larger banks. While that alone is not a good reason to invest in a stock, it can be a nice kicker when it happens.

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