THE BLOG

Banking's Good, Bad And Ugly

11/21/2009 05:12 am ET | Updated May 25, 2011

"Hey Dan, There's an old saying: If you're going to do something, you might as well do it right. The problem is you did it wrong," complains Hal Klauser. "I am referring to your recent "Don't Bank on It" article, where you wrote about the risks to banks from their commercial real estate loans. You make the same mistake that every other business writer does when he writes about this subject. No names. Your readers are not mind readers. Which banks are you talking about? Who are the bad guys?"

In an e-mail, Klauser writes he also believes if the recession is over and the economy is on the mend, as the experts are saying, banks should be among the major beneficiaries of the recovery. "So which bank stocks." he asks, "would you recommend buying?"

Before getting to the answers, Hal, it's worth noting that the plight of the nation's banks -- due in large measure to rising unemployment and faulty commercial real estate loans -- is broadly expected to get progressively worse. So far this year, 94 banks have failed and estimates, depending on who you believe, widely call for another 500 to 1,000 to go belly up in the next two to three years.

That said, let's look at the banks -- the good, the bad and the ugly -- though the eyes of the team of banking analysts at Morgan Stanley.

First to the bad, with the focus on 16 banks heavily exposed to problematic commercial real estate geographies, in that they have more than 0.5% of their total CRE loans in the states showing a combination of the greatest increase in vacancies to date and expected increases to peak.

Leading the way with total CRE exposure to at-risk markets (with percentages in parentheses) are South Financial Group (4.8%), M&T BK Corp. (3.2%), Bank Hawaii Corp. (2.7%), Zions Bancorp. (2.6%), Regions Financial Corp. (2.2%), Synovus Financial Corp. (2%), and Comerica (2%).

Rounding out the list are TCF Financial Corp. (1.8%), Marshall & Isley Corp. (1.6%), Washington Federal (1.4%), Huntington Bancshares (1.4%), Wells Fargo Corp. (1%), Boston Private Financial Holdings (0.9%), Valley National Bancorp. (0.6%), JPMorgan Chase (0.5%) and BB&T Corp. (0.5%).

Of this list, Morgan Stanley is least concerned about JPMorgan based on its strong multi-family portfolio.

If indeed some real estate experts are right in their assumption that CRE is a disaster waiting to happen, obviously ugly times could lie ahead for the banks with the heftiest involvement in this area. Of the banks Morgan Stanley checked, the biggest CRE exposure, as a percentage of total loans, is East West Bancorp (53% of its loan portfolio), South Financial Group (37%), Zions Bancorp (37%), Valley National Bancorp (35%), Boston Private Financial Holdings (33%), and Synovus Financial (32%).

Okay, what about the good? Operating on the premise that credit will improve over the next 12 to 18 months as the economy stabilizes, leading to higher earnings and fatter stock valuations, Morgan Stanley is pitching clients on the idea of selectively building positions in large-cap and mid-cap bank stocks even though bank shares are up about 8% since the end of second quarter earnings reports.

In large-cap bank stocks, the brokerage's favorites are Bank of New York Mellon, Northern Trust, Bank of America and JPMorgan. In mid-cap banks, top picks are focused on names that have either raised capital or built reserves sufficient to address their sizable credit concerns. Included here are such banks as First Horizon and Webster Financial.

A word of caution: With the streets and shopping malls of America littered with empty and abandoned retail outlets and office space, there is no easy out for banks, which are saddled with some $1.3 trillion of commercial real estate loans. In other words, bank stock buyer beware! Investing in the wrong bank could land you in the poorhouse.

Write to Dan Dorfman at Dandordan@aol.com