Great City, Great Banks

Earlier this month the Milken Institute study of the best performing US cities and metropolitan areas was released. The study ranks cities on things like job growth, wage growth, technology output and local GDP growth for the year. This study has some real value for investors as strong economic and of growth in a particular city leads to population growth and an increase in city and local tax revenues. Property values will stabilize and begin to recover much quickly in these parts of the country that have strong economic performance. Builders with a strong presence will do better than their peers around the country. Infrastructure contractors will see an uptick in contract awards and an increase in revenues and profits faster than many national companies. REITs with a strong presence in strong market will see higher occupancy rates and lease rates. An astute investor can use the information in the report to find all sorts of investable opportunities.

It occurred to me this morning as my coffee kicked in that the report is probably most useful to those of us that follow and invest in the smaller regional and community banks. A healthy growing job market means the region is going to experience income as well as job growth. This means higher deposits, more loan demand and improving collateral value. The business community will be looking for business financing and contractors will be borrowing to build homes to meet new demand. It is the start of the sweet spot of recovery for banks .Larger banks will want to expand in the region and often the easiest way will be to just buy a smaller competitor. Combining the Milken report with the trade of the decade in small bank stocks could provide some banks with huge potential returns.

The number one region last year was San Jose California. Business IT spending is starting to pick up once again and apps for smart phones and social media are exploding and this helped the region jump fifty spots to claim the top spot. The largest bank in the region is Silicon Valley bank (SIVB) with more than 20 billion in assets. The banks strong presence and reputation in the valley means the shares are not cheap. The bank trades at 1.6 times tangible book value. They have great relationships with the major players in Silicon Valley including the leading companies and venture capital firms.  The stock only trades below book in severe banking sell offs like the early 90s and 2008 but when it does it should be bought.

Heritage Commerce Bank (HTBK) is a smaller institution in the region that does not demand the same valuation premium. This stock trades right at tangible book value and has solid financials. The equity to asset ratio is a healthy 12.1 and nonperforming assets are just 1.56% of total assets. The bank has $1.14 billion in deposits spread among its 11 branches in the area. The bank projects itself as a community bank started by business people for business people and this is reflected in their loan portfolio. More than 80% of their loans are commercial and industrial or commercial real estate loans.  While this might be a red flag in a weaker region this is actually a positive factor in a growing region like Silicon Valley.

The company has been working to further strengthen the balance sheet and enhance its prospects going forward .They redeemed their preferred stock in 2012 and also paid off their subordinated debt prior to maturity. In the third quarter they had 13% deposit growth and posted their 9^th consecutive quarter of profitability. Given the strong growth potential in the region the stock is cheap enough to buy and hopefully scale into even cheaper over time.

Apparently I am not the only one who thinks this is the case. Two insiders were accumulating the stock back in August. Value investing legend Michael Price of MFP Advisors owns almost 5% of the bank. Charles Moore’s Banc Fund Company LLC is also a large shareholder of the bank. In the third quarter of 2012 24 institutions increased or initiated a stake in the bank.

It is worth noting that for those willing to do the work there are several microcap banks operating in the region that are cheap with strong balance sheets and loan portfolios. They are way too small to mention here but some legwork could pay off for bank stock buyers willing to do the work.

As I move down the list on top performing cities I see that Austin Texas is second on the list. The Texas tech center is a perennial top ten city as the city has become a center of technology with Dell (DELL) and IBM (IBM) the largest employers in town. It appears that many residents are about to become cash rich if the Dell deal goes through. The problem with Austin is that almost all of the smaller banks are privately held. The largest banking presence in town is Wells Fargo (WFC) followed by Bank of America (BAC) so it hard to find a bank to buy and get an Austin specific play.

That’s not the case with the town in the third spot on the list. Raleigh, North Carolina climbed 11 spots in the annual survey as the research triangle attracted strong hi tech job growth. Universities are among the largest employers in the area and have been expanding research facilities. Cisco (CSCO) also has a strong presence in the region and has been upgrading their facilities in the region. Open Source software company Red Hat (RHT) also makes it home in Raleigh. The region has one of the most educated work forces in the area as it draws from North Carolina State University as well as nearby University of North Carolina and Duke. Tobacco Road has morphed into the High Tech Highway and the city of Raleigh is a major beneficiary of the transformation.

First Citizens (FCNCA) is the largest, and one of the oldest, banks in the area. The bank was founded in 1898 and has grown to more than 400 branches over 17 states. The bank has taken advantage of the recent crisis to acquire other banks with FDIC assistance and will emerge as one the regions strongest financial institutions. Officers and director of the bank own more than 40% of the outstanding shares so they have a vested interested in growing the bank and the stock price.

The bank traders right at tangible book value this year and is adequately capitalized with a tangible equity to assets ratio of a little over 9. Non-performing assets are over 3% but much of that is covered under a loss sharing agreement with the FDIC. The bank is over reserved with loan loss reserves at 1.62 times total non-performers  First Citizens should grow with the Raleigh metro area and be a solid performer over the next decade.

One of my favorite Trade of the Decade banks has a strong presence in the market. Capital Bank (CBF) is the combination of several smaller banks in the southeast that had their IPO just last year. Several of the banks were troubled institutions on the verge of closing and the deals were done with FDIC assistance. At first glance  the almost 7% nonperforming loan rates looks alarming but it has fallen from over 125 in a short period of time and many of the assets are covered under an FDIC loss sharing deal. Capital Bank has 15 branches with more than $500 million in deposits in the Raleigh Durham region making one of the larger banks in the area.

The stock is cheap right now trading at just 70% of tangible book value. The recent earnings report was not well received by the markets in spite of the fact they beat estimates. The bank also announced a buyback program of %50 million in common stocks. The equity to asset ratio is over 15 so they have plenty of capital to mange loan losses, support buybacks and hopefully initiate a dividend sometime in the future. They not only have a strong presence in Raleigh but also have a good sized presence several other Southeastern top performing cities.

Before I move on from looking at banks that are based in the best performing cities by the Milken Institute I want to look at one more region and share some general thoughts. On the list the dominant state is Texas as the combination of high tech around Austin, oil and gas centered on Houston , low taxes and a business friendly government have made the state one of the best places n America to do business. I wrote about Texas banks not long ago and they should be on your watch list for an opportunity to buy at a decent discount to tangible book value.

Utah is also very well represented on the list to the delight of our resident mountain man, Bob Byrne. A combination of oil and gas, agriculture and tourism have kept the state economically vibrant throughout the current slowdown. Unfortunately for investors most of the states banks are either industrial banks owned by corporate giants like Morgan Stanley (MS) and American Express (AXP). The best play in banking for the state to going to be Zions Bancorp (ZION). The bank has 107 branches with over $11 billion of deposits in Utah and is the 8^th largest by market share. The stock has staged a nice recovery over the past few years but still trade at just 90% of tangible book value I have set up a news feed for bank IPOs of thrift conversion in Utah to see if the future provides any opportunities to take advantage of future growth in the state.

The last region I want to review is my old stomping grounds. The Washington DC economy has been somewhat impervious to the economic pullback for obvious reasons. The Federal Government is the largest employer in the region but every defense contractor, non-profit organization, union and technology company has a strong presence in the region. There are several major universities and research hospitals in the area as well providing yet another stable source of jobs.

It is also one of the more overbanked regions in the United States.  7 of the top 10 wealthiest counties surround the nation’s capital and that attracts financial services companies like honey does bees. I am hard pressed to think of a major money center or regional bank that does not have a presence inside the beltway. Back in the early 1990s the region saw massive bank consolidation in the aftermath of the S&L crisis but De Novo banks popped up on every corner as the decade progressed and once again the region has too many banks and consolidation is likely over the next few years.

Sandy Springs Bancorp (SASR) transformed itself form a small bank in the region to major presence by taking advantage of acquisition opportunities. Since 1993 the bank has purchased 5 institutions and engaged in two branch transaction that increased assert by close to $750 million. The bank has also purchased several insurance agencies and investment offices to expand their offerings in financial services. The currently have 49 offices thought the DC region with $3.9 billion in assets. The stock is a little high right now at 1.3 times tangible book value but it is near the top of my list of regional banks to buy on a market decline.

One of the more intriguing stories in the area is Middleburg Bancshares (MBRG). The bank has branches in the region surrounding the capital and location in Richmond and he Newport News area of the state as well. The bank has 11 branches with a total of $1.2 billion in assets. They also offer trust and investment management services throughout their service area. The stock is currently trading at 1.2 times tangible book value and has adequate capital with an Equity to assets ratio over 9. They real story here is that David Sokol, the investment manager once thought to be Warren Buffets successor, has been steadily accumulating the shares and now owns a little more than 1.5 million shares.  I own a tiny bit of this one and would love to see it pull back below book value and add more.

Like so many other regions of the country the real story in the Washington DC region is the small banks that are too small to cover here. There are dozens of them in the District, Maryland and Virginia that trade at a discount to tangible book value with pristine balance sheets and strong capital accounts. It is worth the time and effort for long term investors to find the safe and cheap bargain banks in the capital region.

The more I consider the idea the more attracted to the idea of mixing the Milken Best Cities report with the trade of the decade as a source of great bank stock ideas for long term profits.