Banking Expert Banks on Regionals

02/21/2014 10:00 am EST

Focus: STOCKS

Doug Hughes focuses exclusively on small to mid-size regional banks—a sector typically off the radar of many investors. The editor of the Bank Newsletter explains the attraction of the sector and highlights a pair of current favorites.

Steve Halpern: Joining us today is Doug Hughes, editor of the Bank Stock Newsletter. How are you doing, Doug?

Doug Hughes: Good. How are you, today?

Steve Halpern: For listeners unfamiliar with your research, you're the newsletter industry's leading authority on small and mid-size regional bank stocks. Could you tell us about your background, and perhaps, what led into your interest in this sector?

Doug Hughes: I've been investing in the banking area, probably, for three decades now. My Web site is BankNewsletter.com. We tend to specialize in the smaller banks, because they're quite easy to understand.

You get to talk to the CEOs, all the top management team, and directly on the phone, if you want, at will. The bigger banks, obviously, you can't communicate with them that easily, and can't understand them that easily.

As well as, we love the idea of takeovers always in the background, so, takeovers are where you make the big money, and these smaller banks, again, a very simple process to understand. You're basically buying people, asset quality, and market area, and it's a simple process to understand.

Steve Halpern: Now, the attraction of these stocks, you've mentioned takeover perspective, but are these attractive for both growth and income investors, are you comfortable with both of those areas?

Doug Hughes: Many of them do pay 3%, 4%, 5%, 6% cash dividends and/or some pay stock dividends. That is another reason to hold them. It, somehow, sometimes limits the downside, but not always, obviously, as we have seen in the market crash the last six or seven years ago, but sure.

I mean, definitely, the cash dividends are great additions to the income and they basically pay us to wait, until these banks are taken over.

Steve Halpern: Now, the small bank area is very, very specific. Are there particular metrics that you focus on when selecting regional banks?

Doug Hughes: We like to have growth in earnings, the positive market share. We like, number one, the positive market share of the bank in their market, and whatever prospective market they're in, and we like the affluent markets.

A market with more high-net worth people, they tend to attract the higher takeover prices and/or takeovers, the ones in rural, low income areas, tend to not attract any takeovers.

Steve Halpern: Now, will you share some specific ideas in the regional banking sector for our listeners, the ones that you find particularly attractive now?

Doug Hughes: Sure, I mean, some of these banks have no growth, so, the only way to increase their earning power is to buy somebody here that has growth and number one deposits market share in many of the fast growing markets.

An example of that would be C&F Financial (CFFI) in Westport, Virginia. The CEO, Larry Dillon, has been there for 35 years, plus, the bank is trading at a p/e of 6 or 7, if you can believe it. It's only $2 over book value.

Number one in deposit market share in many of their markets, great asset quality, a well-diversified portfolio of businesses that they run. The bank is easily worth 100% more in a takeover. It pays a 3% cash dividend.

Insiders own 8% or 9% so they want to get paid someday. That's somebody that is an example of a prime takeover candidate, and/or the very limited downside risk, due to their earnings power, their growth, and their market share.

Steve Halpern: Is there one other stock that you would share with us?

Doug Hughes: Sure, there is another one. The next one, the symbol would be (THFF). They're in Indiana, a very large bank. First Federal Financial Corporation. Again, their book value is $27.

The stock is trading around, it just moved up from $30 to $33, or so, just a few dollars over book. It pays also a 3% cash dividend, trades plenty of volume.

If you do buy any of these stocks, always use market limits. They are thinly-traded, as compared to a larger regional, or a Bank of America, for example, but again, very strong asset quality, great people, great management team, and they're expanding like crazy.

Steve Halpern: Well, we really appreciate you sharing your expertise with us. Thanks for joining us, today.

Doug Hughes: You're welcome. Thanks for having me.

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