Value Expert Banks on Banks

05/01/2015 9:36 am EST

Focus: FINANCIALS

Benj Gallander

President, Contra the Heard

Contrarian investing specialist Benj Gallander looks for long-term, deep value situations; here, the editor of Contra the Heard looks at the banking sector and highlights four favorite stocks.

Steven Halpern: Our guest today is Benj Gallander, a value investing expert and editor of Contra the Herd newsletter. How are you doing today, Benj?

Benj Gallander: I am doing very well, Stephen, how about yourself?

Steven Halpern: Very good. Thank you for taking the time today. Your long standing expertise involves out of favor stocks. Could you tell us a little about this turnaround-type strategy?

Benj Gallander: We look at companies that are out of favor. Effectively, deep value plays, so for the portfolio that I manage, I only buy into companies that have been around for, at least, ten years. I’m very debt adverse so I like buying into companies that have low debt or zero debt.

We look very carefully at financial ratios, at the management of the company, but I don’t buy anything that’s new and exciting. It’s all companies that have traded at much higher prices.

I’m always looking for gains of 100%, 200%, 300% plus and all the companies that I buy into have traded at those much higher levels in the past.

Steven Halpern: So, in order to get that type of return, you’re willing to buy and hold onto for the long-term.

Benj Gallander: Well, to a degree, our average hold time is about three and a half years and some people say that that’s an awfully long period of time, especially with all the technology now and everything being quicker and quicker.

There are some companies in the past that I’ve held for over ten years, but often their returns have been 400% to 500%, some with dividends, so it certainly is worthwhile to hold if those circumstances present themselves.

Sometimes I get lucky and sell a company within a year when I buy it, but that really doesn’t happen all that often.

Steven Halpern: Now, one sector in which you do see long-term potential is the US banking area. What attracted you to this sector and where does the banking group now stand?

Benj Gallander: Well, the banking sector is one that I’ve been in and out of many times in the past. I remember back in the late 80s buying into Bank of America and Continental Illinois Bank.

The sector often just seems to get hit hard, and of course, the last time was the recession, and when that happened, a lot of the banks went down to less than half or a quarter of what they were at.

They cut their dividends back, etcetera, but we’re seeing, of course, a return in the American economy and the banks are doing better, but I bought very heavily into the US banking sector.

About 25% of the portfolio that I manage is now there and I perceive quite a bit of upside left as the economy does better.

Steven Halpern: Now, many investors are focused on the potential for rising interest rates, is this a positive or a negative in your view for the banking sector?

Benj Gallander: Well, many of the banks stated themselves, when interest rates rise, they do better, so that’s one of the things we’re looking forward to and the interest rates have to go up. Now, when that will be, I can’t say, but I think it’s more likely short-term than longer-term.

And that will improve the bottom line of many of the banks, and as you know, a lot of banks cut or had to eliminate dividends during the recession and after the recession. It would allow some to restore dividends and others to increase dividends along with capital increases.

Steven Halpern: Let’s look at some of the bank stocks you currently own and among your recommendations is Fidelity Southern (LION). What’s the story here?

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Benj Gallander: Well, this bank has come back tremendously after the recession. In the most recent quarter—this month—they just reported record income equivalent to 45 cents a share, they just raised their dividend again to 10 cents a quarter.

They have excellent capitalization ratios and an interesting thing is that insiders own by 26% of the company so they’re definitely invested alongside shareholders and they’ve reported strong auto sales and mortgage loans, which is helping the company, so I can see this one continuing to climb and going over $20.

Steven Halpern: You also recommended Bank of Commerce Holdings (BOCH). What’s the attraction with this?

Benj Gallander: This is a small California bank. They always made money on an annual basis during the recession. They have a nice dividend that they pay and I think will go up in the next couple of years, trades below book value.

A number of insiders have been buying. A key metric for banks is nonperforming assets and they’ve been going down.

It’s interesting to note too that the share count has decreased by about 10% over the past four years, so that means the earnings per share can go up and it’s another bank that can trade at about over double where it is now prior to the recession, so lots of upside.

Steven Halpern: Another bank you own in your portfolio is First Union Corporation (FUNC). Could you tell us about this outfit?

Benj Gallander: This one is a little earlier in the turnaround, but it’s coming along nicely. It’s a very old bank that was established in 1900 based in Oakland, Maryland. They did not dilute the share count during the recession.

It’s just over 6 million shares, and though they don’t pay a dividend now, previous to the recession they paid 20 cents a quarter, so I think that they’ll reestablish a dividend before the end of 2016, maybe just pennies a share, but then I see a lot of potential upside.

It sells at about two-thirds of book value, which is interesting. It currently trades at about 8.50. It used to trade at over $25, and with the industry consolidation going on in the financial sector, it wouldn’t surprise me if somebody comes in to scoop up this bank.

Steven Halpern: Now, as you mentioned earlier, one of the banks stocks that you’re interested in is Bank of America (BAC). What can investors expect from here on out?

Benj Gallander: This bank is obviously much bigger. It used to trade at over $50, so over triple of where it is now. I think it’s recovering quite nicely under CEO Brian Moynihan. He wanted to raise the dividend and finally got approval to do it from a penny to a nickel a quarter.

I mean, it used to be 60 cents a quarter, again, prior to the recession. Their major problem in the past few years has been litigation costs, amongst others, but it seems like they’re winding their way through a lot of the settlements and through the litigation, which means that costs here should go down. That should move towards the bottom line.

If the profit improves, I think they’ll get a go ahead from regulators to increase the dividends and that should also help to boost the stock price. I think if someone who wants a bigger bank, this one has a lot of potential.

Steven Halpern: It’s always a pleasure to speak with you and hear your ideas. Thank you for joining us today.

Benj Gallander: Thank you Steven. Always a pleasure, I look forward to next time.

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