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Two Small-Cap Banks to Play the Real Estate Turnaround

Thursday - 5/23/2013, 4:24pm  ET

David Einhorn, the successful hedge fund manager, has turned bullish on two financial stocks in the first quarter of 2013: Capital Bank Financial and National Bank . He purchased 940,133 shares in Capital Bank Financial and nearly 333,000 shares in National Bank, accounting for only 0.25% and 0.09%, respectively, of his total portfolio. Both of these companies are small-cap banks, with the market cap under $1 billion. Let’s take a closer look to determine the attractiveness of these two banks.

Deposit structure and real-estate loan concentration

Both banks were led by experienced ex-employees of Bank of America. Capital Bank, incorporated in 2009, was led by CEO Eugene Taylor, former VP of Bank of America, who spent 38 years there. The company began its banking operations with the purchase of $1.2 billion of assets and $960 million of deposits of three failed banks from the FDIC. National Bank, incorporated around four years ago in 2009, was also led by Bank of America’s 24-year veteran, G. Timothy Laney. It has also begun its banking operations with the acquisition of Hillcrest Bank from FDIC and a portion of the franchise of Bank Midwest.

Those two banks also possess the similar deposit structure. While Capital Bank had around $2 billion, or 34% of its deposits, in time deposits, around 27% of National Bank's total deposits were time deposits below $100,000. They do not only have the similar deposit structure, but their lending practices are also similar.

For Capital Bank, most of its loans – more than $1 billion, or 22.6% of the total loan portfolio – were owner-occupied commercial real estate. Non-owner-occupied commercial real estate and one- to four-family residential ranked second and third, accounting for 19.1% and 17.8%, respectively, of the total loan portfolio. National Bank also concentrated its loans into the commercial real estate field, with the total loan outstanding balance of $805 million, or nearly 44% of the total loan portfolio while the residential real estate ranked second with $538.7 million in loan balance.

Trading at the discount to their book values

What I like about Capital Bank is its high net interest margin of 4.4%. However, the return on assets and return on equity was quite low, at only 0.77% and 4.88%, respectively. The net interest margin of National Bank is also high, but lower than that of Capital Bank, at nearly 4%. However, the bank experienced a loss of $543,000 in 2012, due to initial  expenses of its public offering, intangible asset amortization, significant increase in salaries and employee benefits and the rise in other real estate expenses.

Capital Bank is trading at around $17.70 per share, with the total market cap of $985 million.The market values the company at 0.85 times its book value and 13.4 times its forward earnings. National Bank, with the total market cap of $963.2 million, has the similar valuation, at 18.6 times forward earnings and 0.89 times its book value. 

This bank offers a decent total yield but is expensively valued

Those two banks seem to be relatively cheap compared to peer UMB Financial . UMB Financial is trading at around $52 per share, with the total market cap of $2.1 billion. It has the highest price-to-book ratio at 1.64 and is valued at 16.3 times its forward earnings. However, UMB Financial delivered the highest return on equity at 8.91%. UMB Financial concentrated its loans into commercial activities, with more than $2.87 billion, accounting for nearly 50.5% of the total loan portfolio. Commercial real estate ranked second, with $1.43 billion, or 25.23% of the total loan balance. The net interest margin was the lowest among the three, at only 2.75%.

Recently, UMB Financial reported a significant drop in its first-quarter earnings. While the interest income decreased from $84.7 million to $83.9 million, its net income fell by 24.7% to $34.9 million. At the same time, the company’s board of directors announced a $0.215 quarterly dividend, payable on July 1 to shareholders of record at June 7. Moreover, it also authorized to buy back up to 2 million shares in the next 12 months. The current dividend yield stayed at 1.65%. If the company could repurchase 2 million shares in the next 12 months, investors could get an additional yield of 4.9%.

My Foolish take

Looking forward, the improvement of the overall real estate market in the U.S. could benefit both National Bank and Capital Bank in the near future, as most of their loans were in the real estate field. UMB Financial, on the other hand, might offer investors better stability, as its loan concentrates on commercial activities. 

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