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Until recently, I would have avoided regional banks. However, the green shoots of the U.S. financial recovery are now sturdy enough that select financial institutions are showing highly bullish charts backed by strong fundamentals. Both the technicals and fundamentals tell me there is a good trading opportunity at hand.
According to the Federal Deposit Insurance Corporation (FDIC), the number of bank failures has dropped dramatically since June 2011. At this time two years ago, 48 banks had entered receivership. By this time in 2012, the number dropped to 31. So far this year, only 16 banks have failed -- one-third the number of failures compared to 2011.
Moreover, revenue and earnings prospects for select regional banks should continue to improve. For starters, the Fed's pledge to keep interest rates near record lows means low-cost loans for consumers, and that translates to strong loan demand at banks. According to Reuters, commercial and industrial loan demand is on the rise. Continued economic growth should spur consumer spending and should further increase demand for loans.
Regional banks are also seeing improving credit quality. With credit issues largely behind them, banks no longer need to stow away large sums of cash to offset problematic loans. According to the trading site Shine's Trading Room, these factors, coupled with stronger balance sheets, mean that "regional banks are positioned for growth in 2013."
However, not all regional banks are created equal, and I believe only those with the strongest technicals and fundamentals should be bought at this stage of the sector's recovery.
Based on its solid outlook, Chemical Financial Corporation (NASDAQ: CHFC) is my top regional bank pick.
Headquartered in Midland, Mich., Chemical Financial is the parent company of Chemical Bank. With 156 offices spread across 38 counties and $6 billion in assets, Chemical Financial is the second largest banking company in Michigan.
According to Chemical Financial's chairman, CEO and president, David Ramaker, the bank continues to "post strong earnings growth" because of lower credit-related costs and organic balance sheet growth. Management anticipates future earnings growth will be driven by improving cost control and loan loss figures.
From a technical standpoint, the bank's growth prospects are certainly favorable.
Since hitting a low near $13.65 in September 2011, shares have formed a major uptrend line and nearly doubled to date.
In March 2013, the stock touched a multi-year high near $26.50, but could not maintain that strength and dipped to support near $23.
Quickly rising off this support level, shares reached a new multi-year high of $26.82 in late May.
The stock has struggled to break this level, which now marks an important resistance level. Shares have since traded in a very narrow rectangular range, finding support above $25. Support held even after the market dropped dramatically in the days after Bernanke first mentioned winding down the Fed's bond purchase program, a bullish sign.
If resistance can be successfully penetrated, the stock would bullishly complete an ascending triangle pattern, marked by the intersection of the major uptrend line and $23 support.
According to the measuring principle for a triangle, calculated by adding the height of the triangle to the breakout level, the stock should reach a minimum price target of $30.22 ($26.61-$23=$3.61; $3.61+$26.61=$30.22). At current levels, this target represents almost 17% returns.
The bullish technical outlook is supported by solid fundamentals.
For the upcoming second quarter, scheduled to be reported on July 22, analysts expect revenue will increase 1.3% to $60.5 million compared to $59.7 million in the year-earlier quarter. For the full 2013 year, analysts project increasing loan demand will help push revenue up 1.1% to $242.1 million from $239.4 million last year.
The earnings outlook is also solid.
For the upcoming second quarter, analysts estimate earnings will dip slightly, to $0.48 per share from $0.50 per share in the year-earlier quarter. However, for the full 2013 year, analysts anticipate asset growth combined with credit-cost reduction will see earnings rise 3.2% to $1.92 per share from $1.86 per share last year.
In addition to an upbeat technical and fundamental outlook, the stock has an attractive forward annual dividend yield of about 3.2% ($0.84 per share), which should help support the share price. Management has maintained a quarterly dividend in the $0.20 range since 2001, although there was a dividend cut from $0.29 per share in 2009 to $0.20 per share in 2010.
Risks to consider: Signs of an economic recovery are helping boost regional bank stocks. As the economy picks up, consumer spending should increase, causing loan demand to rise. However, if economic activity is more sluggish than anticipated, decreased loan demand could hurt regional banks like Chemical Financial.
Recommended Trade Setup:
-- Place a buy-on-stop order on CHFC at $26.63-- Set stop-loss at $22.89, just below current support-- Set initial price target at $30.22 for a potential 13.5% gain in six months
Once a pillar of the American economy, this group is crumbling, and investors would be wise to avoid the rubble.
After a solid run, the technical evidence tells us shares are headed for a quick drop.
This sector is one of the few showing real growth, and there is an undeniable upside catalyst on the horizon.