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Monday, April 15, 2013

California Dreaming

When I was a kid the image of California was almost magical to those of us who lived on the East Coast. California was palm trees, cable cars and movie stars. When I first made it to the Golden State in my late teens I was enthralled by the entire state and eventually moved there for a few years. The reason I left in the early 1990s were a foreshadowing of what is happening there today. The rapidly rising taxes and ridiculous government policies were among the chief reason I fled the state and that has all gotten worse not better over the next two decades

Today when we think of California we tend to think of bankrupt cities like Stockton, fallen real estate values in the aftermath of the crisis. The state and local governments seem to make the news almost daily for some ridiculous new proposal or proposition and the external view of the state is one of poor government and a failing economy. The unemployment rate is close to 10% and the state is viewed as outright hostile to business with its heavy tax burden.

However it is important to keep in mind there is a lot to like about the state. There wouldn't be so many people there if it was not a great place to live. California has a strong agricultural economy and Silicon Valley remains as robust as ever. They have enormous shale oil and gas resources that could add millions of jobs if the legislature doesn't screw it up too badly. They have two of the best baseball teams in the country right now, and most importantly they have banks. California has a lot of banks that are still very cheap as a result of the disastrous real estate markets during the crisis and the economic situation. Separating the winners from the losers in the state can be an enormously profitable exercise.

I will start with an observation that seems to pop up every time we look at the community bank stocks, Many of the larger ones have traded up and are at a premium to tangible book value. Most of these premiums are small in the range of 1 to 1.25 times TBV but they are still too high to chase at the moment. A strong market pullback could change this but for now resist the urge to chase banks stocks trading above book value. Most of the value right now is the smaller institutions.

The larger banks in the state have already recovered while few were watching. The two larger institutions associated with the Asian markets have soared off the bottom. East West Bancorp (EWBC) has risen by more than 5 fold off its lows while Cathy Bancorp (CATY) has merely doubled. SVB Financial has ridden its high tech relations hips to a gain of more than 5 times the lows in a few short years as well. All of the California banks with more than $10 billion in assets now trade at a premium to book value.

When we away from the larger metropolitan area banks however the picture begins to change and its worth investigation to find some bargain banks for our Trade of the Decade portfolio. When we look at the thrifts we stumble across one of my favorite financial institutions right now First Pactrust Bancorp (BANC).  I have mentioned the bank several times in recent article and I am a big fan of the stock. They are transitioning into a full service commercial bank; the shares are cheap at 72% of book value and the stock yield more than 4% so it qualifies as an income story as well as a candidate for large long term appreciation.

Another thrift trading at a bargain valuation is Simplicity Bancorp (SMPR) of Covina.  The bank started as a credit union to serve employees of Kaiser Foundation Hospital, grew into a mutual thrift savings and in 2010 completed the second step of the conversion process to become a stockholder owned saving bank in 2010. In 2012 the name was changed from Kaiser federal Financial to Simplicity as part of rebranding effort. Simplicity has 9 locations currently with $890 million in assets.

This is simply a well-run community bank with a solid balance sheet. Nonperforming assets are 2.8% of total assets. 85% of the loan portfolio is single or multifamily housing with almost all of them first mortgages so they have no real exposure to the riskier home equity and second mortgage loans that have plagued other California institutions. The bank has completed two 5% buyback programs and just announced a third repurchase plan. Although the dividend yield is modest right now at 2.1% the equity to asset ratio of 14 leaves plenty of capital for future increases. The shares trade at just 85% of tangible book value and represent a solid value for long term bank stock investors.

One that catches my eye and seems worth investigation and investment is Pacific Mercantile Bank (PMBC). The bank just sold an additional $14 million worth of stock to their largest shareholder< carpenter and Company. Carpenter runs a specialty fund that is registered as a bank holding company and makes private equity like investments. The funds were transferred to a new asset management division and will be used to buy nonperforming loans and foreclosed real estate from the parent company. This will help with the continued efforts to clean up the bank’s portfolio and improve operating performance going forward.

The efforts have been working as nonperforming assets have declined steadily over the past two years. The bank I positioning is itself to participate in the economic recovery of California with an continued focus on commercial lending and SBA lending.68% of the bank’s loan portfolio is in commercial real estate and C&I loans so the Costa mesa based bank in the right spot to profit as business conditions improve. The company has seven branches on the LA area with over $1 billion in assets. The stock is cheap at less than 90% of tangible book value and is a fantastic way to participate in the eventual recovery and growth of the Golden State.

One of the intriguing banks in the region is United Security Bancshares (UBFO) of Fresno. Fresno is in the San Joaquin valley which was one of the hardest hit regions in the country during the real estate collapse and prices are just now showing signs of stabilizing at much lower levels. Shares of the bank have shot forward this year as the bank turned a profit in the fourth quarter but are still cheap at 84% of tangible book value.
This is definitely a long shot bank as they have some problems. Nonperforming assets are falling but are still quite high at more than 5% according the latest FDIC call report. The bank has been solidifying its loan loss reserves and working off its large supply of real estate acquitted through foreclosure and restructuring and this should continue as housing in the region stabilizes. Most of the real estate was acquired through the construction loan portfolio and should be easily sold when development activity sees renewed activity. To preserve capital the bank has halted cash dividends and has been paying a stock dividend since 2008.
The bank faces a potentially difficult turnaround but the officers and directors seem to feel that it can be accomplished. More importantly they are backing their convictions with cash. In the last six months insiders have purchased more than 175,000 shares of the bank. I wouldn’t bet the farm on United Security but it is worth owning a few shares as an asymmetric payoff potential bet on a California recovery.

Since the  credit crisis began I have been watching and eventually buying the smaller banks as I believe that they will recover as they did in the aftermath of the savings and loan crisis. The valuation, especially of the smaller community banks, represents solid values with enormous potential returns. This is especially true of those banks in the hardest hit regions that survive, recover and eventually either thrive or get acquired.

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