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Jonathan Moreland

Inside the Markets

Why insiders find significant buying power in banks.

October 15, 2007
by Jonathan Moreland

DISCLOSURE: Readers should assume that all stocks mentioned in this column are owned by the author and/or his firm unless otherwise noted.

I went back to “fully invested” mode after the Federal Reserve Bank’s bold interest rate-cutting move last month. Also, I’ve finally started adding to my positions in the understandably maligned financial sector. Some of my first additions in the group were a couple of regional banks, a group that was particularly heavily bought by insiders during this summer’s correction.

Small and regional banks are often ranked highly by automatic insider scoring mechanisms that fail to differentiate properly between directors receiving shares in the bank as remuneration, and real open-market purchases. But I dug into the histories of the banks bought this summer and found that most of them had truly significant buying.

Frankly, I’ve never been keen on adding banks to the recommended list of my InsiderInsights.com newsletter. Sure, you can try to game the constant trend of consolidation in the group, but I never felt analyzing the quality of a bank's assets was my specialty. I also suspect others were likely mistaken to think they really knew what certain assets on these balance sheets were worth.

All that is at the forefront now, however, and the truth will surface in upcoming quarters as write-offs are forced by increasingly attentive regulators and shareholders. While investors have understandably sold stocks of small and regional banks as the credit-related storm blustered through the headlines this summer, insiders seem to be indicating that many became oversold. So far, insiders have been right, and have generally made money on the group. I finally joined them last month, and added both Huntington Banc (NASDAQ: HBAN), and New York Community Bancorp (NYSE: NYB) to my list.

To be clear, I did not recommend these banks because I feel the credit crisis is over for them, or that it will bypass them. I bought them because they appear to have attractive metrics even considering the write-offs and wrangling that is inevitable later this year and throughout 2008. That’s a pretty brash thesis. But I’m only placing a small bet on it right now.

Huntington is more of a classic bank play. Its shares are beaten up with the group even while it has promise for cost savings from a recent acquisition. Its Tier 1 Capital of 9.7 percent appears reasonable, and the bank’s admittedly high nonperforming assets (equal to 1.0 percent of loans) is seemingly already priced into the stock as it trades for 1.6 times tangible book value. HBAN could also be a takeover candidate itself.

While it would be nice to think the stock’s 6.3 percent indicated yield is real, that, and EPS estimates, will undoubtedly fall if nonperforming loans increase sharply.

New York Community Bancorp is a different fish. Its shares have held up well during the summer. Since its loans are to apartment complexes, news of unattainable single-home mortgages or higher unemployment affect it less. If people can’t afford a home for any reason, they rent.

The knock on NYB is that management continues to pay out a dividend over and above its earnings. Nonetheless, with Tier 1 Capital of 12.8 percent, and minimal nonperforming loans, this stock’s indicated yield of 5.4 percent appears safe.

These new positions could end up being short-term trades — due to spikes either up or down. As with all my stocks, however, I would hope they become long-term holdings. The Fed’s larger-than-expected lowering of rates last month has certainly helped these stocks now, but also serves to highlight the real risk in these positions. The bottom line is that any improvement to banks’ net interest margin that the latest (or future) rate cuts create is negligible compared to the harm to assets that a real recession would cause. So to the extent that Fed rate cuts are absolutely necessary to save the U.S. economy, they are a net negative for banks.

But the people who should understand these risks the most have certainly voted with their wallets, and they do not expect a worst-case scenario for their banks. At Huntington, six executives and directors purchased nearly 21,000 shares last August at an average price of $17.04. At New York Community Bancorp, six insiders invested over $2 million in their shares at an average price of $16.17. Both stocks are already higher, but have hardly gotten away for any investor who cares to bet along with insiders that the economy is more likely than not to muddle through its recent travails without falling into a full-blown recession.

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Jonathan Moreland is the Director of Research at New York-based Insider Insights.com. Click here for a FREE trial issue of the firm's weekly newsletter Insider Insights.