Bank Bets: New York to Palo Alto

03/21/2014 10:00 am EST

Focus: STOCKS

Doug Hughes, explains the attraction of smaller, regional banking stocks; here, the editor of Bank Newsletter, also highlights two current favorites in this niche market.

Steve Halpern: Joining us today is bank sector expert, Doug Hughes. How are you doing today, Doug?

Doug Hughes: Good, how are you?

Steve Halpern: Very good. In your Bank Newsletter, you specialize in smaller regional banks. Could you briefly explain for our listeners the attraction of these smaller firms relative to the larger national financial institutions?

Doug Hughes: The main attractions are, usually, you can speak to management and get to know them on a personal basis, and/or they have a valuation that’s just much simpler and easier to understand, and usually they’re at a small niche market where they can write much better profits than the bigger banks if they’re run correctly.

Steve Halpern: Now, are these also areas where you’re looking at these banks and other analysts may not be following them closely?

Doug Hughes: Yeah, a lot of the smaller or mid-sized regionals are trading, maybe 10,000, maybe 20,000 shares a day and that’s probably not enough shares or volume for the bigger mutual funds—hedge funds—to get involved in these situations.

Steve Halpern: Okay, today we’re going to walk through two specific investment ideas that you find attractive in the banking sector. The first is Chemung Financial (CHMG), a New York-based operation that happens to be one of the oldest banks in the country. Could you tell us a little more about that?

Doug Hughes: Correct. It was established in 1833, if you can believe it. It’s just an upstate New York bank that’s probably doing quite a bit of expansion.

They’ve just picked up a bunch of branches from Bank of America, in summary, the same markets, decent growth college towns, and they’ve expanded to Albany area of New York where there’s definitely some better growth and they seem to be growing their loans, finally, at a decent clip, and management owns 25% of the stock.

The hidden asset on this one is they own almost a $2 billion fund that they actually manage at their bank. It’s bigger than the size of their bank in assets, so there’s some definitely some value there.

It’s trading just $2 over book value, pays a 3.5% cash dividend, and, if it was to sell out, which is one of the main reasons to own these community banks, its worth, at least, double the current trading range.

Steve Halpern: So, when you look at a bank like this that could possibly be a buyout, I assume you like the bank—if it remained as an independent, you would still like the operations?

Doug Hughes: Of course. Always. This bank has earning power of $5 a share, if it was run correctly. Currently it’s earning under $3 a share, and/or if management is gone, the top 10 guys pay themselves over $2.5 million, right there is another 70 cents in earnings per share.

So there’s many ways to value this company, but I always go by earnings. That’s the number one thing, if there is no takeout, and $5 times a fee of, say $12, would give you the $60 buyout price, which would be even low.

Steve Halpern: Now, you also like the outlook for a company called AVIDBANK Holdings (AVBH), which you notice is a fast-growing bank in an area that’s best known for its technology companies. Could you share your thoughts on AvidBank?

Doug Hughes: Sure, also, this one is a completely, basically, opposite of the slower growth Chemung areas. This is in Palo Alto, California, the hottest part of the country, where Facebook is headquartered. Tons of new technology companies, old technology companies, everybody is in this market.

They do all kinds of commercial lending, so all different types of offers. And the one thing that you have to be careful of here is, they’re not having any bad loans, this bank has none. It’s run by very smart management. Management owns 25%, also, of the stock here.

They also did a secondary back about nine months ago, the management bought 25% of that, institutions bought the rest. It was like a private placement to raise capital because they’re growing so fast. This bank, in this type of market, is worth at least two times book.

Currently, it’s trading about one times book, maybe a buck over that, and has earnings power here of $2.50 a share next year, once it gets running on all cylinders, which, again, gives it a buyout price, honestly, over $25, and it’s currently trading at only $11.

Steve Halpern: Well, we appreciate you taking the time today. Thank you so much for joining us.

Doug Hughes: You’re welcome. Have a nice day.

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