The island of Puerto Rico, with its cool Atlantic northern waters and bath-like Caribbean beaches, its mountainous interior and myriad microclimates ranging from alpine to jungle, has always held allure for adventurers, be they conquistadors, pirates or corporate investors.

The conquistadores and pirates are long gone, but lately, investors have been pulling out too, taking jobs with them and leaving behind a local government that is increasingly challenged to raise enough tax revenue to pay its bills.

Coming on top of the 2006 phase-out of a decades-long tax exemption for companies that set up operations on the island, the reverberations of the global financial crisis have thrown Puerto Rico's economy into a deep recession now in its seventh year.

The slump has hit virtually every business based in Puerto Rico, but at least one stock analyst thinks investors have been too negative on some of the island's nine banks.

Brian Klock, who covers Puerto Rican, Canadian and U.S. regional banks for Keefe, Bruyette & Woods, has been arguing that four of Puerto Rico's banks, and especially Banco Popular, the dominant competitor, with operations both on the island and on the U.S. mainland, are actually in a strong enough position to weather the island's economic crisis and even to turn in solid performances. This would be true, he asserted in a Dec. 19 report, even if one or more of the major ratings firms were to lower the island's credit rating to junk—which both Moody's and Standard & Poor's did in February.

Klock is quick to acknowledge that recent and future austerity measures undertaken by the local government "could cause the island's economic contraction to worsen, thus increasing credit risk for the banks." But coming out of Banco Popular's Jan. 23 earnings call with analysts, Klock said he thought the bank's shares, then trading at about $28 (where they continued to trade at press time), were "deeply discounted" by investors overly focused on the credit downgrade issue.

"There's a decent amount of short interest in the bank by people who don't know Puerto Rico very well," Klock says. "That's why I like it." He says KBW has a target price of $34 for the stock—a 20% upside potential that he terms "pretty conservative."

Klock also has kept from turning negative on three other island banks: Oriental Financial Group, which also is on his "buy" list, and First BanCorp and Scotiabank de Puerto Rico, a subsidiary of Canada's Scotiabank.

While each institution's situation is different, all have taken significant steps to shore up capital and reduce nonperforming loans, Klock says. And, he adds, each has a unique catalyst that should help boost earnings, sovereign credit rating downgrade or not.

Banco Popular, for example, has sought the green light from regulators to repay its $935 million from the Troubled Asset Relief Program—something the bank's executives claim they can do without raising equity funding.

On the earnings call, Banco Popular Chairman and CEO RichardCarri-n told analysts, "All of us at this table are ready to repay TARP as soon as possible, but it's in the regulators' hands. When they say to go ahead, we're ready."

Klock says that if the TARP investment gets repaid, then "the bank should be a value stock this year and will have a good chance to start returning capital to investors next year."

Also currently undervalued, Klock says, is Oriental Financial Group. He expects Oriental to gain market share in the disruption caused by the island's financial difficulties, and says the bank can further grow earnings thanks to its 2012 acquisition of BBVA PR, the Puerto Rico subsidiary of global player Banco Bilbao Vizcaya de Argentina.

Local competitors FBC and Scotiabank don't have as much opportunity for growth in Puerto Rico, says Klock, who rates both of these stocks "market perform." But he says these banks are in a position to expand in more favorable places, with FBC focusing on the Florida market, and Scotiabank focusing on other parts of the Caribbean.

Not all analysts covering Puerto Rico's banks are so sanguine, even about the stronger competitors. Morgan Stanley analyst Ken Zerbe notes that the Government Development Bank of Puerto Rico's Economic Activity Index fell again in December by 5.7% year-over-year. This, he says, suggests that instead of finding a bottom, the island's brutal recession is continuing—which he says could force banks to increase their provisions for bad loans. At $2.15 a share, his 2014 earnings estimate for Banco Popular is 27% below Wall Street's average forecast.

"Street estimates do not reflect the magnitude of the island's deterioration," Zerbe says.

Chris Wolfe, managing director of the bank group at Fitch Ratings, says the island's banks in general have been taking the right steps to operate in a difficult time, but says they "still need to do a better job of cleaning up their assets."

The recent downgrading of Puerto Rico's credit rating would likely mean downgrades for the island's banks. (As Wolfe explains, "We typically don't rate banks higher than the country they operate in.")

But based on recent stock valuations for Puerto Rico's banks, which dipped only slightly after S&P's sovereign credit rating downgrade and barely budged when Moody's followed suit a few days later, expectations of a ratings cut have been baked into the shares—and into the mindset of local bank executives, Klock says—for some time.

"Banco Popular, OFG and the others assumed a downgrade was likely and that growth would stay negative this year," says Klock, who has been to the island to meet with financial institution executives, "and so they all have stronger capitalization levels than they had going into the last crisis."

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