With the majority of the banking industry by assets having reported third quarter results, FBR Capital Markets believes that some of the dire scenarios discussed may have hit bank valuations harder than underlying fundamentals indicate.

"The banks were able to show decent loan growth in select asset classes, net interest income looks to be more resilient than expected, and credit has continued to improve, albeit at a slower pace. That said, we have become incrementally more positive on bank stocks going into the end of the year," said Paul Miller Jr., an analyst at FBR Capital Markets.

While bank performance may be sensitive to European sovereign debt and the shape of the yield curve, Miller believes investors may start to see the space as "good value" rather than "uninvestable."

Fundamentally, loan growth has started to pick up for most big banks and Net Interest Margin (NIM) has trended down, as expected. However, Net Interest Income (NII) has increased slightly as asset growth and deposit re-pricing have offset asset yield declines.

According to Miller, out of the 24 banks under coverage that have reported earnings, the median growth in total loans was 1.2 per cent this quarter, compared to a 0.5 per cent decline in the first quarter of 2011 and a 0.7 per cent growth in the fourth quarter of 2010.

This growth in lending was led by Commercial and Industrial (C&I) loans, which grew 4 per cent sequentially and has been particularly strong at regional banks, such as First Niagara Financial Group (FNFG), People's United (PBCT), Fifth Third Bancorp (FITB), PNC Financial Services Group (PNC) and U.S. Bancorp.

Miller said his main takeaways were total loan balances, which experienced their first quarter of widespread growth. Competition for loans remains strong, particularly at rates that should suggest some concern, given that this is not a good environment to grow loans in; the fact of price competition only makes things worse.

Miller said his takeaways also include NIM-contracted 6 basis points to an average of 3.52 per cent, as expected. However, NII increased slightly and mortgage banking was weaker than expected since most of the activity was at the back end of the quarter, which should bode well for a good fourth quarter and credit trends continue to improve, albeit at a slower pace.

Miller recommends investors favor regional banks with solid revenue growth, improving cost structures and a larger portion of the revenue from mortgage banking. Miller's top ideas include Fifth Third Bancorp, Wells Fargo (WFC), PNC, Webster Financial (WBS), First Commonwealth Financial (FCF) and National Penn Bancshares (NPBC).

Twenty of the covered companies reported declines in NIM, leaving only four with reported increases - F.N.B. Corp. (FNB), First Horizon (FHN), Fifth Third Bancorp, and Comerica Inc. (CMA). However, Miller noted that earning asset growth is mitigating the impact of margin compression and is allowing net interest incomes to increase.

Loan balances for the companies that have reported in grew 5 per cent (annualized) in the third quarter of 2011, an improvement over the last quarter. Eighteen of those companies saw increases in their loan balances, while six - Astoria Financial (AF), Bank of America (BAC), Comerica, Huntington Bancshares (HBAN), TCF Financial (TCB) and Washington Federal (WFSL) - saw decreases.

C&I is still the main driver of loan growth. However, Miller is beginning to see green shoots in the residential and indirect auto portfolios. Demand remains weak, which means that banks have to gain market share in order to grow loan portfolios.

Mortgage banking activity grew 35 per cent in the third quarter of 2011 as low interest rates drove strong refinance activity and mortgage banking income increased this quarter. However, it was not as strong as the activity indicates.

"We believe that relatively soft mortgage banking income was due to the activity occurring primarily near the end of the quarter. As a result, a considerable amount of the revenue recognition should spill into the fourth quarter of 2011 and low rates will likely keep activity elevated. This should bode well for banks with larger mortgage banking operations," said Miller.