Small Bank Betting

06/03/2016 10:00 am EST

Focus: FINANCIALS

Doug Hughes

Editor, BankNewsLetter.com

Doug Hughes focuses on regional and small banking stocks; here, the editor of Bank Newsletter looks at the outlook for the sector and highlights three favorite investment ideas with strong upside potential and limited downside risk.

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

Doug Hughes:  Great.  How are you Steve?

Steve Halpern:  Very good.  Thanks for taking the time.  Now, when considering bank stocks, the market’s been preoccupied with the outlook for interest rates.  Could you give a quick overview on what you see for interest rates and the potential impact on the regional bank stocks that you follow?

Doug Hughes:  Sure.  Just as we said at the beginning of the year, we still expect there to be rate hikes.  Everybody’s been all over the map, as you see on the TV, with no rate hikes or up to four or five rate hikes, but we just held steady at three.  

We think we’re going to get one this month, one in June and we think we’re going to get another one in September or December and generally, that helps these community regional banks.

For example, our pick last time we spoke, Iberia Bank (IBKC), every time they raise the rates a quarter point, they make 7% more on their money, so that’s quite a bit of an increase.  

Not all banks will have that, but many of these smaller and mid-sized regional or any of the community banks will make anywhere from 3% to 8% on every quarter point hike, so generally it’s a great positive.  

Steve Halpern:  Now I know you focus very heavily when you’re assessing a bank, you look at the high quality of management, as well as strong finances.  Could you walk our listeners through a quick overview of the primary factors you consider when selecting stocks?

Doug Hughes:  Sure.  Well first of course, again yes, you’re always buying people when you’re buying a bank, so the people have to be top-notch.  

We like a great market area where it’s a high income area and/or a high gross and then you obviously have less asset quality problems, if it’s a high income area and more likely in a takeover cabinet.  Most banks take it over are generally very strong asset quality, very strong people and very strong fluid market.  

Steve Halpern:  Now turning to a few individual stocks, one you like is Commercial Banks Shares (CMOH), which is based in Ohio.  What’s the attraction here?

Doug Hughes:  We’ve liked this stock for many, many years and it just continues to grind higher.  The bank earns roughly close to $3 a share this year, which puts it at a p/e of around 9 to 9 1/2.  

The have a 5% stock buyback in place for the bank.  Insiders are always buying the stock also.  Book value is around $33 a share, so we’re trading around $29, $30.  

It’s about 10% under booked, with a PE of that again nine or so.  It’s hard to beat that.  There are very, very few bad loans.  The management has been there forever.

If they were to sell out, it’s worth at least $40, $44 a share.  It’s a nice 3.5% cash dividend while you wait.  They’ll probably actually pay an extra special dollar of cash dividend, I have a feeling this year.  

They had somebody die at the bank and they got a cash settlement for life insurance. Usually they pay that out to shareholders, but either way, you basically have no downside in a tremendous choppy high-priced market and you know 35% to 40% upside and you get paid while you wait.  I mean it’s just the safest bank out there and it’s basically a no-brainer.

Steve Halpern:  Now another regional bank you consider is based in Pennsylvania and it’s called Univest (UVSP).  What’s the story here?

Doug Hughes:  This is a much larger bank, about 10 times bigger than the one we just talked about.  Trades plenty, so you don’t have to use so much limits to buy and sell it.  Also pays a 3.5% to 4% cash dividend.  

Its very nice that management is usually buying the stock.  Usually they buy the stock back.  They have an open buyback program in place as well.  

This is 104-year-old bank.  The other bank was 100 years old.  This is something that also we love is Season Bank.  

The sleeper here is this bank also has a $ billion trust division, which is at least equal to the size of their bank, worth quite a bit of money in today’s market, if the market stays at these levels.  

They’re doing a big merger with Fox Chase Bank that closes at the end of this month -- the end of June -- and I think people are a little concerned with the stock.

They have to issue about 6.9 million shares to close this deal, but net net, the banks trading again only about 10% overbook and they generally buy banks about 1.9 times book in this market, so if you do the math, this bank itself is worth lower $30s.  

It sits here at around $20, and is just a mispriced stock, with a fair value of around $24 to $25. Basically you get no downside and tremendous growth.  They’re in upper Maryland and many rich areas of Pennsylvania which are very solid, stable, strong markets.  

Steve Halpern:  Now, outside of regional banks, you’ve also suggested Oppenheimer Holdings (OPY), which is an investment banking firm.  What attracted you to this situation?

Doug Hughes:  This bank, again, we’ve been following for many years.  They came within a couple of days of going out of business in the crash, but they made it.  

Their tangible book value is $24 and change.  The stock is at $15 and change, so if they close their doors today, you would make basically 40%, 50% on your money. They also pay a 3% plus cash dividend and they’re also buying stock back.  

They also have very, very smart management.  Again, with the market at these levels, the firm is not going to go out of business and I think they’ll sell this firm due to the regulatory concerns.  

They’re just bombarded by costs.  The regulators are in there at this company every month and if they sell out, they have to be worth at least $30 a share, which is 100% gain, which is hard to believe in this market.

But these are the mispriced securities that are out there; and again, very low downside risk, a little bit more than the banks we just talked about because it is a financial institution, but again this is about as cheap as you’ll find a stock in the stock market.

Steve Halpern:  Again our guest is Doug Hughes of Bank Newsletter.  It is always fascinating talking to you.  Thank you so much for your time.

By Doug Hughes, Editor of Bank Newsletter

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