Bank Guru's Trio of Takeover Targets

12/07/2015 10:00 am EST

Focus: FINANCIALS

Doug Hughes

Editor, BankNewsLetter.com

Doug Hughes, editor of Bank Newsletter, specializes in small and regional banking stocks. Here, he discusses a trio of banks that he believes offer strong upside potential and limited downside risk; he also considers each to be a  potential takeover candidate.

Steven Halpern:  Joining us today is Doug Hughes of Hughes Investment Management and editor of The Bank Newsletter, which specializes in small and regional banking stocks.  How are you doing today, Doug?

Doug Hughes:  Great, Steve.  How are you?

Steven Halpern:  Very good.  So, historically, could you share a general outlook for the regional bank sector?

Doug Hughes:  Many of the regional banks have been moving up here substantially in the last several months—especially ones in the hotter growth markets—as everybody’s anticipating higher rates here that still never seem to come, but maybe they’ll come this month.

Steven Halpern:  Now, as you alluded to, people are expecting a Fed rate decision that could lead to higher rates.  What would the impact of rising rates be on small banks?  

Doug Hughes:  Most of the banks will benefit but we really need to see two, three, four, or five, six rate hikes over the next year or year and a half.  If we just get one or two rate hikes it’ll help the banks a little bit in their profitability but not a whole lot.  

Steven Halpern:  Now, could you walk us through some of the factors that you consider when assessing takeout targets within the banking sector?

Doug Hughes:  Takeout targets, we would look for small banks with no growth, management owned a lot of stock and had been there forever and they’re just basically waiting for things to turn—which it looks like they finally have here—and they have no growth, they want to sell.  

The other side is banks that are in hot markets that have been growing very, very fast and they can get great price, maybe two to two and half times book instead of just book or book and a half in a deal and then they sell out that way because everybody wants growth.  It’s very hard to find if you’re not in a good market.  

Steven Halpern:  Now, you’ve been particularly successful in picking banks that have turned out to be acquired and you currently like three where you see takeover potential. The first is Midland Capital (MCPH) which is based in Illinois. What’s the story here?  

Doug Hughes:  This one is in Bridgeview, Illinois with four locations.  The main location has almost 60 million in deposits, which is quite large for a small bank. That’s definitely worth some value to somebody.  

Management owns over half the stock.  It’s a family run bank. They’ve been there.  The two brother's been running it for half a decade. The bank is almost a 100 years old.  

They have no bad loans and basically they have shrunk the bank instead of growing the last ten years. Ten years ago the stock was over $40, the bank was earning $4 a share, now the bank’s barely making money and they’ve shrunk the bank down to about 120 million in assets.  

The guys are both in their 60s, and again, they own over half the stock, no bad loans, and they have 30...the book value is 33-1/2 in cash and six to ten in book.

Real estate value that is not in the book, so we’re looking at a $45 takeout price when the stocks trading at $15 to $19. A lot of us see this as a tremendous home run and there’s basically no downside when there’s no bad loans.  

Steven Halpern:  Now, you also recommend a New York-based bank called Chemung Financial (CHMG).  What’s the attraction here?  

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Doug Hughes:  This one’s in Elmira, New York, over a 100 years old.  One of the oldest banks in the country.  Insiders here again own a bunch, not as much as the other one, but about 15% to 18%.  

The bank actually has been growing a decent amount.  They’ve been acquiring other branches from other banks that are dispersing like Bank of America, et cetera, but their markets are very slow.  

They have a big trust department which is almost $2 billion in trust assets and their bank itself is only $1.6 billion in assets, so combined, this would make a nice fit for somebody up there that has some growth markets.  They have plenty of capital to expand their loan portfolio.  

This one’s trading, not as cheap as Midland, but it’s trading around book and this one would be worth about one and a half book times book due to its strong earnings power and its strong asset trust division.  No bad loans really here either to speak of and a 3.5% cash dividend while you’re waiting for them to be taken.  

Steven Halpern:  Now, finally, you like Avidbank Holdings (AVBH), of California. Could you share your thoughts here?  

Doug Hughes:  So, this one’s completely different from the last two.  It’s only an 11-year-old bank.  Insiders do own over 20%.  The bank’s growing like a weed.  

It’s in the hottest market in the country in Palo Alto.  Banks here would go for two to three times book.  The earning power here is just the beginning. They have tremendous earnings power in the next five years.  

Very few bad loans; basically had none for almost six years.  They had a couple last year but they seemed like they worked those out and the non-performing loans are down to a .5%.  

Earnings power is probably $3 a share, a few years out.  The bank has to be worth at least mid-20s and today it’s trading at 13 and change.  

There’s a very, very strong management team here, and again, completely different than the other two.  It has more risk because it’s in hot growing markets.

But the management seems to be very disciplined and everybody wants these strong growing markets like I said, so somebody’s going to want to take them either today or five years from now depending on what the management team wants to do or if they get an offer they can’t refuse.

Steven Halpern:  Now, I’ve noticed some of these small bank stocks are thinly traded.  Would you have any specific recommendation or advice on how best for an individual investor to buy these stocks?

Doug Hughes:  Yes, all three of these banks are thinly traded.  Some have a half point spread, some have a quarter point spread, some have a $2 spread, some trade thousands of shares a day from 1000 to 50,000 and some trade a few hundred.  On all three of these they all trade a few hundred to, again, several thousand a day.  

Always use limits when you buy and sell it, and basically, any stock in the country unless you’re buying Exxon Mobil (XOM) as a trader or you want to get in and out in lightning speed. But I would still recommend using limits on any stock in the last ten years in this market.

Steven Halpern:  Again, our guest is Doug Hughes of the Bank Newsletter.  Thank you so much for your insights today.

Doug Hughes:  You’re welcome, Steve.  Have a great week.

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