|
Bet Against the Doomsters with Puerto Rican Banks
By Michael Brush
November 24 2005
Puerto Rican banks have been a great place for value investors to lose money
this year. They started to look cheap last April after falling steadily for
months, ahead of early warnings of a potential accounting imbroglio.
Since then – which isn’t uncommon for value plays – they have only gotten
cheaper. The accounting scare, as if often the case with bookkeeping issues,
have just gotten scarier.
advertisement
The most recent turn for the worse came as the Securities and Exchange
Commission (SEC) upgraded investigations of some of these banks to “formal”
status over the past few weeks. And at least one bank has filed papers with
more details of what might have gone wrong.
The main concern
The chief issue: Whether mortgage loans “sold” by several Puerto Rican banks
were truly sold, or were they merely transferred as part of what would end
up being a kind of loan? If the sales were actually loans after all, that
means recent financial results reported by these banks are bogus. When
investors catch wind of this kind of scenario, they sell.
The problem for the banks is that converting sales to loans would reduce
cash flow and income reported in recent years – bringing potentially huge
restatements. A reclassification could also hike the amount of money these
banks need to reserve against the “new” loans, the loans that were once
considered sales.
The “culprits”
So far, it looks like three banks may be in hot water. They are: Doral
Financial (DRL), R&G Financial (RGF) and First Bancorp (FBP). Not
surprisingly, their stocks have been smacked around the worst this year,
falling as much as 80%.
But other Puerto Rican banks have gone along for the ride, as investors
suspect any problems may be more widespread. These include: Popular (BPOP),
EuroBancshares (EUBK), W Holding (WHI) and Oriental Financial Group (OFG).
How bad is this accounting issue and when will it be cleared up? It’s
notoriously hard to study an emerging accounting problem and make that call.
Many investors prefer to sell first and ask questions later, which is why
these stocks have been slammed. And SEC investigations can drag on for
months.
So it’s simply too hard for outsiders to know if the shares of Puerto Rican
banks – especially the second group not yet hit with real accounting worries
– have reached bottom.
Insiders, however, have offered a view of sorts on the matter -- by
purchasing stock. I’d take it as a sign that maybe the accounting issues
aren’t as serious as investors think, and that these stocks have gotten
beaten down so much that they are worth owning.
The insider buying
Here’s a closer look at the cluster buying in this group.
- Insiders at EuroBancshares – one of the banks not yet formally
linked to accounting questions – purchased a hefty $2.4 million worth of
stock for prices between $10.40 and $10.67 at the end of October and
early November. The stock recently traded for $12.64, but it is down
from $22, earlier this year. It trades for a price to book value of 1.58
and a forward price earnings (pe) ratio of 11.7. To put that in context,
many regional banks these days trade for a price to book ratio of at
least 2 and a forward pe of 14 or more.
- At Popular, insiders purchased $475,000 worth of stock for prices of
around $22.55 to $21.54 in mid-November. This bank has a price to book
ratio of 1.99 and a forward pe of 12. Popular, so far, has not been tied
to any accounting problems.
- There’s also been a smattering of insider buying at two other banks
not directly linked to accounting issues. They are: Oriental Financial
Group ($73,000 in buying for $12.55 to $13.94) and W Holding ($42,000 at
around $7.80). These two trade for exceptionally cheap valuations of
around 1.16 times book value and 9.7 times forward earnings.
Time to make a move
But they’re not as cheap as the banks directly tainted with accounting
issues, of course. Doral trades for a minimal .77 times book value and 5.6
times forward earnings, while R&G Financial (where insiders were selling in
November) goes for .96 times book and a forward pe of 6. That’s cheap.
But will they get even cheaper and burn value investors who step up now,
just like value investors got burned throughout this year?
The insider buying at a cluster of these banks says no. We may be near the
low for these stocks, this time around.
Don’t forget that business conditions – mortgage lending – remain strong in
Puerto Rico, say analysts. “The boom in mortgages on the island continues,
with Doral Financial, R&G Financial and Popular dominating,” says Audrey
Snell, who covers the group for ThinkEquity Partners. “The franchises of the
various banks appear to be intact, and business appears to be robust.”
And there could conceivably be a simple solution to many of the accounting
woes, suggests Snell. If sales of mortgage loans aren’t deemed to be true
sales, banks could simply renegotiate many of these transactions to make
sure that they are.
Other challenges
Even if the accounting issues vanished entirely (not likely), you need to
remember there are challenges that prevent Puerto Rican bank stocks from
quickly returning to levels seen earlier this year.
For one thing, Snell says, heightened competition has reduced fees. Next,
banks in general face the annoyance of a “flat” yield curve – which is a
horizontal plot of interest rates, or yields, on various loans depending on
when they are due. With a flat yield curve, short-term rates for loans of a
few months aren’t that much lower than rates on loans of ten years or more.
This hurts banks’ “net interest margin” or the amount of money they can make
doing what they do best. That is, borrowing short term at lower rates
through instruments like deposit accounts, and lending long term at much
higher rates – through mortgages or other types of multi-year loans.
On the bright side, the fragmented Puerto Rican banking sector looks ripe
for consolidation. Buyouts or mergers could jolt some stock prices. Besides,
many of these banks, like Doral, simply look too cheap. Snell recently
upgraded her rating on Doral and set a twelve-month price target of $15. The
stock recently traded for around $10.
The bottom line: This group is risky, because accounting issues can
spin out of control rapidly. But that’s why they’re cheap. And cluster
buying by insiders suggests investor fears are overblown. I think the best
approach is to buy one of the Puerto Rican banks not yet touched by
accounting issues, the ones where insiders also happen to be buying the
most. They are: Popular or EuroBancshares. Then, if you have a tolerance for
risk, buy one of the banks directly linked to accounting issues. They have
been hit so hard, they’ll spring back more if it turns out the accounting
problems aren’t as bad as sellers think. Here, I’d go with Doral.
Disclaimer
At the time of publication, Michael Brush owned shares of Popular and Doral.
Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About
Insiders Corner:
http://www.investorideas.com/insiderscorner/. InvestorIdeas.com
Disclaimer:
www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not
affiliated or compensated by the companies mentioned in this article.
|
|
