Small Bank Guru's Best Buys

08/31/2015 10:00 am EST

Focus: FINANCIALS

Doug Hughes

Editor, BankNewsLetter.com

Doug Hughes specializes in small and regional banking stocks. Here, the editor of the Bank Newsletter, explains the important metrics and fundamentals that he looks for in a purchase candidate and highlights two favorites for current investment.

Steven Halpern: Our special guest today is regional banking sector expert, Doug Hughes, editor of the Bank Newsletter. How are you doing today, Doug?

Doug Hughes: Great, how are you, Steve?

Steven Halpern: Very good. Thanks for joining us. Investors who focus on large banks seem preoccupied with the Fed as well as with the extreme volatility in global markets. With the regional focus of the small banks that you focus on, could they be viewed more independently from these concerns?

Doug Hughes: Yes, Steve, they certainly can. The big banks—as you can see with the volatility the last week—have traded all over the place, when the smaller banks, while they've been generally down, don't have any type of volatility.

Most of their business is local, domestic. There's no international exposure or worrying about another currency devaluation. It's just a completely different ball game.

Steven Halpern: In terms of what the Fed does in terms of interest rates, would rising interest rates necessarily be bad or would it be helpful for the sector?

Doug Hughes: It really depends on the bank on a case-by-case basis, but it's generally the spread and spreads have been tightening here again, but for these smaller community banks, basically, growth is their number one engine.

You know, a strong economy means strong profits. The spread over the last year has just continually gotten tighter, and you know, you can't even worry about that. That's out of their hands.

Steven Halpern: As they say in real estate, location is everything. Does the same apply when you view regional banking stocks?

Doug Hughes: It does and it doesn't. In community banking, you're buying people. You know, people are the number one assets. Number two is the market share that they're in.

Is it a high growth market, is it a wealthy market, very affluent. Does another franchise want to get in there? Do they have a dominant deposit share? The number one factor is people, second is location, third is asset quality.

Steven Halpern: Now when you look at banks, you also assess their yields as well as whether or not they're buying back their own stock. How important are these factors when you're selecting a bank stock idea?

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Doug Hughes: It is quite important. Buying back their own stock is good as long as it's at opportunistic levels where the price is very, very cheap, easy on their book. Banks that just buy it back for any reason, we don't like. As far as buybacks go over the last year, they come and go.

I mean, generally, the smart banks do buy the stock back when it's cheap. If it's a larger regional, sometimes they just buy back the shares because they need them for their directors, you know, just to make good shareholder noise. That we don't like.

Steven Halpern: Do you also look for whether or not the stock is offering a dividend yield or is that specific only to each bank idea?

Doug Hughes: As far as the yield goes, most banks we follow that seem to the best usually pay 1%, 2%, 3%, or 4% yield. Those are the ones that seem to consistently grow the dividend and/or just take it over.

If the yield is 5% or 6%, generally the bank is usually very solid but it's just a slow grower in a smaller, non-growth market where they usually don't sell but they pay you a nice yield while you sit with the stock for many years.

Steven Halpern: Now, one banking idea that you are recommending is WesBanco (WSBC). What's the story here?

Doug Hughes: This bank has tremendous management. They're located in Wheeling, West Virginia. Very, very strong market that they're in. They've done quite a few acquisitions themselves over the past few decades, which is something we usually don't like, but this bank has always executed every acquisition flawlessly.

Management doesn't pay themselves a lot. It's very well run and the earnings growth and potential here is tremendous. Upside would be at least 25% or 30% if they were to sell in a deal.

Steven Halpern: Now, you're also a fan of Fulton Financial (FULT). Could you share your thoughts on this situation?

Doug Hughes: This is, again, another large regional bank in some of the hotter New Jersey, Pennsylvania markets.

There has just been a couple quite sizable deals in Pennsylvania, both at between one and three quarters about average per book, which would translate Fulton's current price of $12 to about $16, $17 in a deal.

Fulton's management does buy stock back. They've been aggressively buying it back the past year. Management again is very prudent here, very smart, and just some very strong markets they're in. Pays about a 3% yield.

Somebody would definitely want this franchise and we started adding aggressively to the stock right here at this level around 12, a little bit under, a little bit over.

We feel the overall market is going to be very choppy if not down the next several months but this is when you can pick up these shares very cheap.

Steven Halpern: Again, our guest is regional bank stock expert, Doug Hughes. Thank you so much for your time today.

Doug Hughes: Thanks very much, Steve.

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