By now, we now the sad story of the large national investment banks like Bear Stearns, AIG, Citigroup et. al.. Such examples give pause to investors, as they should, but they also taint the entire financial sector.

Believe it or not, there are many banks that stuck to lending and banking principles and never ventured into derivatives and toxic assets. Shares in these banks, usually small, regional banks, have taken a hit. Call it guilt by association. It’s unfair, but it creates great opportunity for investors who can stomach the kind of volatility that often accompanies such subjective discrimination.

Here are three smaller banks, recently recommended by SmartMoney magazine.

Provident Financial Services (PFS)
Provident is a well run, new jersey bank with a solid balance sheet and enough cash on hand to ride out the current recession. Provident has 82 branches and only 1.5% of their loans are “nonperforming”, which is well under the industry average. The stock trades at 1.1 times the tangible book value, which is cheap for any sector.

City National (CYN)
City National is located in Beverly Hills, CA and caters to the affluent (think high-end Hollywood). Analysts expect earnings to rise sharply in 2010. They currently have $28 billion in assets, and $13 billion in deposits. Though the price has fallen 26% on worries of exposure to California’s pummeled real estate market, analysts say that the bank has high quality assets and earnings should “rise significantly.”

TCF Financial (TCB)
While loan losses have been increasing, this Midwest bank has a stable deposit growth and commercial leasing business. This is by far the riskiest bank on the list, but it shouldn’t be destined for bailout/failure country. Analysts say the “repair work is ongoing”, which may make for a few more rocky quarters, but patient investors should be rewarded.

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