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Forget Investing In Big Banks, These Financial Stocks Are Safer

Michael Vodicka

Despite the negative reports from the media, big banks have been popular investments in the past four years.

Not only did the group provide leveraged exposure to economic growth, but they were also a good source of income, with Wells Fargo (WFC) carrying a dividend yield close to 3% and JPMorgan Chase (JPM) boasting a 3.3% yield, both well above the 10-year Treasury note's 1.95%.

But with the recent flare-up in Cyprus, the European Union just provided a stark warning on big bank stocks: Proceed with caution.

After almost four years of relative stability, big bank stocks appear to be extremely vulnerable to global economic volatility. And that is a big risk for investors.

It's clear that bank stocks are still making huge bets despite supposed restrictions on proprietary trading from the Dodd-Frank Wall Street Reform and Consumer Protection Act. That was obvious when JPMorgan Chase shamefully announced a $6 billion loss on a trade gone wild.

In addition to risky proprietary trading, big banks are also leveraged. That's great when the economy is expanding, but it’s potentially big trouble during a contraction. And right now, there are clear signals of an economic slowdown going into this summer, with ADP’s April jobs report coming in below expectations and the March Institute for Supply Management’s non-manufacturing report showing its slowest growth in seven months.

Big banks also have more international business and frequently carry exposure to wider global assets in less-developed and regulated economies. That produces more volatility in the balance sheet for banks and their required capital levels.

But this doesn't mean investors should abandon bank stocks altogether. In fact, there is a great way to gain the benefits of big bank stocks without the added risk.

Regional bank stocks also provide exposure to economic growth and pay hefty dividends. These are the types of stocks you might find in Carla Pasternak's High-Yield Investing. But unlike big banks, regional banks are much more conservative.

Regional banks don't have risky proprietary trading groups making wild bets. They are usually much less leveraged than the leading investment banks. And they don't carry much exposure to less regulated markets and securities.

When you look at the big picture, there are more than a few good reasons why regional banks stocks look like a great alternative to big bank stocks.

Here are four regional bank stocks with yields of as much as 4.7%.

From the group, I have chosen to highlight FirstMerit (FMER) because of its strong capital reserves and Old National Bancorp (ONB) because of its compelling valuation.

This Ohio-based bank holding company has a market cap of $1.73 billion, making it the largest regional bank on the list. 

FirstMerit is benefiting from Ohio's lower unemployment rate of 6.7%, which is below the national average of 7.7%. The bank has a strong financial profile and appears well-capitalized. Tangible capital is up to 8.16% from 7.86% last year, providing the company with more protection against economic volatility, but a little less operating leverage

But analysts are still bullish, projecting 12% earnings per share (EPS) growth to $1.40 in 2014 and annual growth of 6% in the next five years. That's ahead of the industry average of 5%. FirstMerit also carries a solid dividend yield of nearly 4% -- twice the 1.95% yield of the 10-year Treasury note. 

Old National Bancorp
This bank holding company operates primarily in Midwest states such as Illinois and Indiana. With a market cap of $1.32 billion, Old National is a midsize regional bank. 

The bank has shown steady growth for the past two years, with shares up nearly 27%. But analysts are calling for another good year, with EPS expected to grow 13% this year to $1.07. That has Old National trading with a forward P/E (price-to-earnings) ratio of 12 times, a discount to its 10-year average of 16 times and peer-group average of 15 times. Old National also carries a solid 2.9% dividend yield.

Risks to Consider: Regional bank stocks suffer from higher borrowing costs because they don't enjoy the assumption from the market that they will be bailed out of a liquidity or solvency crisis. Higher borrowing costs compress margins.

Action to Take --> Regional banks are some of the safest bank stocks in the market and offer an excellent alternative to larger domestic and international banks operating in higher-risk markets and securities. These four regional bank stocks have strong capital ratios and offer compelling yields. From the group, I like FirstMerit because of its strong capital reserves and Old National Bank because of its compelling valuation.

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