Hughes Banks on Small Banks

10/10/2003 12:00 am EST

Focus:

Doug Hughes

Editor, BankNewsLetter.com

Douglas Hughes is the editor of the Small Bank Newsletter. He has been investing in this area for over 20 years. He looks for small banks, which are not well followed, pay dividends, and offer limited downside risk. He notes that they are great business, and prime takeover targets. Says Hughes, "Each month we personally speak to the management in over 100 banks and find the best values."

Says Hughes, "Here are the seven questions that must be asked before you invest in any small bank stocks:

  1. Asset quality – is it the best?
  2. Franchise value - what is this worth?
  3. Make sure the bank hasn't overpaid for a merger in the past few years.
  4. Look for hidden assets not reflected in their book value.
  5. Make sure the bank is growing by at least 15% every year.
  6. Make sure management is smart and shareholder friendly.
  7. Make sure loan loss reserve is adequate.

"This is getting to be a tough game to watch, with many banks going into the bubble phase. Sit tight and sell any high priced bank that you still own please, and avoid any bank trading over 2.5 times book. I know I sound like a broken record, but this is simply a time to sell highly priced issues and accumulate the few that haven’t moved or that have come down sharply, like Greenpoint Financial (GPT NYSE), which operates a mortgage banking business and a New York retail bank. Due to the recent sell-off in the stock, we would get back in on this one for both short- and long-term investors. Accumulate under $30.25 and buy all you can under $29. Worth $50 in a deal long-term and look for a short-term trade up of about 10% over the next 3-4 months." Meanwhile, here is Hughes' latest new buy recommendation:

"Carrollton Bancorp (CRRB NASDAQ) is  engaged in general commercial and retail banking business with 10 locations located in the Baltimore City and surrounding areas of Maryland. Total assets are $328, loans are at $ 197 million, and deposits are $231 million as of 6/30/03. They also have a network of 152 ATMs located in Maryland, Virginia, and West Virginia, which should help the bottom line after this year. The positives are that they have a great franchise, spread out across a very good market and that management owns 20%+ of the stock. Hopefully, they will sell soon.

"Earnings have just not come in and growth is negative in many categories. The bank has almost $29 million in high cost CDs that are re-pricing this quarter, which will also help the earnings next year. The Bank paid a 5% stock dividend at the end of October last year and we would look for the same this year. They also pay a 2.5% cash dividend. Hence, if we get a total 7.5% return (as the stock usually comes right back to the original price with a stock dividend within a few months), and we have strong takeover potential and low downside risk, that is all we can ask for in this overall high priced bank stock market.

"If everything goes right for them in 2004, look for a strong earnings rise and 5-10% appreciation in the stock price. If not, look for a sale around $27+ a share. They have only 2.8 million shares outstanding and trading at around $17.25 a share is just $5 a share over their book value of $12 +. Most banks in their market area get at least 2.5 times book in a deal of their size. Asset quality is ok with non-performing loans a little high at 1.24%, and reserves at 1.88% (very nice). Net charge-offs have been a low 0.10% on average the last four years. The management’s salaries are also quite reasonable in this market, showing that they are committed to shareholder value. Accumulate now under $17.5 and buy all you can under $16. Downside should be limited by around 10% in this hot market even if asset quality fell apart."

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