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.

Related Articles
  1. Stock Analysis

    Will J.C. Penney Come Back in 2016? (JCP)

    J.C. Penney is without a doubt turning itself around, but that doesn't guarantee the stock will respond immediately.
  2. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  3. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  4. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  5. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  6. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  7. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  8. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  9. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  10. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center