Bank on the Golden State

 | Apr 04, 2013 | 5:00 PM EDT
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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. Rapidly rising taxes and ridiculous government policies were among the chief reasons I fled the state and that has gotten worse instead of 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 be in 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.

But it is important to keep in mind that there is a lot to like about the state. There wouldn't be so many people there if it weren't a great place to live. California has a strong agricultural economy and the 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, California has banks -- a lot of banks that are very cheap because of the economy, a disastrous real estate market and the financial crisis. Separating the winners from the losers can be an enormously profitable exercise.

The state's larger banks have 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 fivefold off its lows while Cathay General Bancorp (CATY) has merely doubled. SVB Financial has ridden its high-tech relationships to a gain of more than five 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 move away from the larger metropolitan area banks, the picture changes and it's worth investigation to find 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 recently and I'm a big fan of the stock. It is transitioning into a full service commercial bank. The shares are cheap at 72% of book value and the stock yields 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 (SMPL) 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 savings bank in 2010. In 2012, the name was changed from Kaiser Federal Financial to Simplicity as part of a rebranding effort. Simplicity has nine locations 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, and 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.

California is often painted as something of an economic disaster, and some of that is well-deserved based on the real estate collapse and poor government, but the state has the underpinnings and resources to rebound. As the state recovers, so will the banking industry. The bank stock bought cheaply today can be sold dearly in the future.

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