This uncertainty afforded readers an attractive entry point into Texas Capital Bancshares (NasdaqGS: TCBI) and F.N.B. Corp (NYSE: FNB). Our investment thesis has paid off thus far: Shares of Texas Capital Bancshares are up 45.3 percent since May 20, 2010, while an investment in F.N.B. Corp is up 30.7 percent.

Although some of these gains can be attributed to improving sentiment toward the banking industry, these two names dramatically outperformed the KBW Regional Banking Index, which managed to eke out a total return of just 8.2 percent over this period. In 2011 improving loan performance should boost earnings at many banks.

 
Source: Bloomberg

Both Texas Capital Bancshares and F.N.B. Corp will benefit from this trend, albeit not to the same extent as riskier fare. That being said, with solid franchises and growing local economies, Texas Capital Bancshares and F.N.B. Corp remain good long-term bets.

Don’t Mess with Texas

Researchers at the Federal Reserve Bank of Dallas have noted that since the 1970s Texas’ economy has avoided three of the six US recessions thanks to elevated or rising oil prices. And the state’s output and employment growth outstripped the national economy from 2005-08.

At the same time, a collapse in energy prices in 1985-86 combined with a real estate bust to spark a rolling regional recession in Texas and a wave of bank failures. But the lessons of 25 years ago clearly stuck. The state largely avoided the housing boom and bust thanks to a law capping loan-to-value ratios at 80 percent, while efforts to reduce the economy’s sensitivity to oil and gas prices also provided a bit of ballast. In 2008 oil and gas extraction accounted for roughly 7.1 percent of the state’s gross domestic product, compared to 13.7 percent in 1985.

Ratification of the North American Free Trade Agreement in 1994 and the state’s central location have made it a hub for international and domestic trade, while many high-tech companies call Texas home. Low taxes, inexpensive cost of living and a business-friendly environment continue to draw transplants and businesses.

Texas largely avoided the economic pains many states suffered in 2008, but a collapse in global trade and energy prices hit the state hard in early 2009, pushing unemployment to its highest level in 22 years. Employment losses subsided in the second half of the year, and January 2010 marked the first month of job creation, a testament to the state’s resilient economy. After losing 362,500 jobs in 2009, the Texas economy had regained roughly half of those positions in the nine months ended Sept. 30, 2010.

As you can see in the graph below, the natural resources and mining industries have been a big part of this recovery. 

Source: Federal Reserve Bank of Dallas

Texas banks have benefited from this strength. Only 15 percent of banks in the state were unprofitable in 2009, compared to 30 percent at the national level. Credit metrics at Texas banks have also been far superior to those at the national level.

Back in May 2010, shares of Texas Capital Bancshares traded at a discount to its peer group, reflecting elevated credit costs and nonperforming assets that amounted to 2.6 percent of its loan portfolio.

Up 45.3 percent since May 20 of last year, the stock has benefited from improving sentiment toward the financial sector and the ongoing US economic recovery, but company-specific factors are the real story behind the company’s outperformance.

For one, Texas Capital Bancshares managed to growth net revenue 21 percent in 2010, one of the few community banks to generate meaningful organic growth. Much of this stems from a 12 percent increase in total loans, a trend that has prompted management to forecast loan growth of 6 to 7 percent in 2011. All these loans are vetted by the bank’s central underwriting committee to ensure quality.

Some of this uptick in business stems from the strength of the major markets it serves–Dallas, Houston, Austin and San Antonio–but much of the company’s growth stems from management’s unique strategy: Rather than pursuing whole-bank acquisitions, management focused on poach top talent from its rivals. With many larger banks focused on balance-sheet repair rather than growth, Texas Capital Bancshares was able to win market share among middle-market customers.

At the same time, Texas Capital Bancshares’ efforts to expand its treasury management operations have been a boon to deposits, which were up 29 percent year over year in 2010. Demand deposits increased by 61 percent, significantly reducing funding costs.

The company’s strong core earnings, and the robust Texas economy, helped to offset elevated credit costs in 2010. Going forward, management expects improving credit quality will be a welcome tailwind. In the fourth quarter, non-accrual loans declined to 2.38 percent of total loans from 2.83 percent at the end of the prior quarter, while the amount of potential problem loans declined more than 50 percent to $25 million. Overall, fourth-quarter credit costs declined to $14.3 million from $17.2 million in the previous three-month period.

Speculation among analysts that Texas Capital Bancshares might be a takeover target have sent the shares higher in recent weeks, though the banks’ future remains bright even if it remains independent. A number of larger institutions have expressed interest in expanding into Texas because of the state’s resilient economy and growing population.

Dallas-based Comerica’s (NYSE: CMA) recent acquisition of Sterling Bancshares (NSDQ: SBIB), a quality franchise weighed down by ill-advised commercial real estate loans in formerly booming markets, sent investors scrambling to find similar takeover targets. Comerica paid a 30 percent premium based on Sterling Bancshares’ last closing price before the deal.

At current levels, shares of Texas Capital Bancshares price in any upside. We’d wait for a correction in the broader market before establishing a new position.

New Energy

For years, banks in the Northeast have envied their counterparts in the Sunbelt, where population growth and economic development provide plenty of business opportunities. But the discovery of the Marcellus Shale, a sedimentary formation that occurs primarily beneath Pennsylvania, New York and West Virginia, could serve as a meaningful growth catalyst.

Although many of these regions have never been a hotbed for natural gas production, activity and output has ramped up quickly, particularly in Pennsylvania, which many in the industry currently regard as the heart of the Marcellus. Check out this animated graphic put together by Penn State’s Marcellus Center for Outreach and Research.

Source: Penn State’s Marcellus Center for Outreach and Research

As you can see, Pennsylvania in 2007 received about 100 requests for vertical wells, and permitting requests in 2008 increased to about 500 vertical and horizontal wells. Thus far in 2010 regulators have granted more than 2,700 well permits, primarily for horizontal wells.

We were ahead of the curve when we highlighted F.N.B. Corp (NYSE: FNB), with its 220 branches in the Marcellus Shale region. In September, investment bank Stifel, Nicolaus & Co. issued a research report on banking stocks with exposure to the Marcellus, and Bob Ramsey, an analyst at FBR Capital Markets (NYSE: FBR), initiated coverage of the stock in December and rated it “Outperform.”

Management has also noted that market dislocation in the Pittsburgh market caused by PNC Financial Services’ (NYSE: PNC) acquisition of National City and distractions at Citizens Financial Group, a US super-regional bank owned by the Royal Bank of Scotland (NYSE: RBS), afforded F.N.B. opportunities to grow loans and deposits organically.

In the fourth quarter of 2010, the company added 170 new middle-market clients and managed to grow its commercial lending book for the seventh consecutive quarter. On the year, F.N.B. Corp increased its average total loans by 2.3 percent, while its treasury management business also boosted the amount of low-cost deposits.

In addition to these tailwinds, the bank should also benefit from lower credit costs as it continues to wind down its Florida loan portfolio, the vestiges of an ill-advised expansion into the Sunshine State at the height of the credit bubble. Management expects the percentage of nonperforming assets to continue to decline and estimates that provisions for loan losses will decline 20 to 25 percent in 2011.