Banking is a fragmented, diverse universe. There are over 9,000 institutions insured by the FDIC holding more than $10 trillion of assets. Size runs the gamut from $242 billion market-cap Citigroup (C) to $40 million market-cap Shore Bancshares (SHBI).
Many of these institutions earn the lion's share of their money by borrowing from depositors at one rate and lending at higher rates. The Federal Reserve has made this money-generating paradigm difficult by increasing short-term interest rates 17 consecutive times to 5.25 percent. Smaller, more traditional regional banks (those less dependent on underwriting and services income), in particular, have felt the sting of higher rates as the yield curve has inverted.
Fortunately, the yield curve isn't going to remain inverted in perpetuity, which is why I like banks that will benefit when the curve normalizes. A few of my favorites reside in the under $1 billion market-cap arena and include Texas United Bancshares (TXUI), First Charter Corp. (FCTR), and Capital Bancorp (CBC).
My overall favorite, though, is a little-known Puerto Rico-based bank called Oriental Financial Group (OFG), which provides financial services to professionals, business owners, and consumers in an increasingly affluent part of the world.
Oriental has been squeezed by rising short-term rates and falling long-term rates, to be sure. First-quarter earnings, reported July, showed net income declined to $6.9 million, or 28 cents per share, from $15.2 million, or 58 cents per share, earned in the year-ago period thanks to constricting lending spreads.
The squeeze is likely to continue into the immediate future. Consensus EPS estimates have been lowered in 2006 and 2007 to 72 cents from 90 cents and 88 cents from $1.12, respectively.
The earnings squeeze has squeezed Oriental's stock as well, dropping the price from March 2004's high of $29 to today's $12 and change. Also squeezing the stock are questions over accounting treatment for certain mortgage transactions. In March, Oriental announced it would reclassify $85 million in residential mortgages as commercial loans secured by first lien mortgages.
In most instances, the reclassification would be much ado about nothing, but a close competitor, Doral Financial (DRL), had its stock decimated in the wake of a multi-year restatement that sliced $694.4 million off retained earnings.
But Oriental is no Doral. Based on current depressed prices and projections, Oriental is a value play. Its price-to-earnings ratio is lower than the average industry multiple of 13, and its price-to-book ratio of 1.12 is significantly discounted to the industry average of 2.23. What's more, Oriental is well capitalized, carrying $3.40 in cash per share and a tier 1 leverage capital ratio of 9.67% (more than 2.4 times the minimum of 4.00%).
In short, Oriental is a relatively inexpensive takeout target under most acquisition metrics.
But whether alone or paired, Oriental should thrive. Earnings growth will return when the normal yield curve does – or even before. Management is making the company less sensitive to interest-rate vagaries; the strategy is beginning to pay dividends. Total non-interest income for the recent quarter increased 46.7% over the year-ago period.
While waiting for the return of a more favorable lending environment, investors are buttressed by a 4.60% dividend yield and a management committed to repurchasing $15.1 million of company stock.