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Commonwealth Bank: Twice The Growth, Half The Cost – 60% Upside In 6 Months, Target Price $37


This article provides a summary of five of the key players in the “Asian American Bank space”: Commonwealth Bank (OTCQB:CWBB), Cathay Bank (NASDAQ:CATY), East West Bancorp (NASDAQ:EWBC), Hanmi Bank (NASDAQ:HAFC) and BBCN Bancorp (NASDAQ:BBCN). We discuss the merits of each bank and then provide comparisons to assess relative valuation and demonstrate how Commonwealth Bank is dramatically undervalued.

While most all banks took a hit in 2007-2009, many Asian-American banks were hit especially hard due to their exposure to Southern California commercial real estate. BUT – these banks are now in a position to thrive. These are primarily Korean-American and Chinese-American banks that serve their respective communities. They are based in the Greater Los Angeles area, with additional branches in other cities where their ethnic groups live. These banks live and prosper along with their ethnic communities. More importantly, they have two key elements that will generate growth: (1) their footprint is largely in the robust economy of California, and (2) increasing trade across the Pacific – both imports and exports – will provide ample opportunity for these banks to flourish.

For each bank, we discuss the strengths and weaknesses, and then provide a comparison to assess relative valuation. Valuations are compared using standard operating and valuation metrics for each of our five banks as they compare to the Five Bank Average. The metrics include:

· Return on Average Assets (ROAA)

· Return on Average Equity (ROE)

· Price to Trailing 4 Quarters Earnings (P/E trailing)

· Price to 2015 Estimated Earnings (P/E forward).

· Price to Tangible Book Value (P/B)

· Tangible Common Equity Ratio (TCE Ratio)

· Efficiency Ratio (Effic. Ratio)

The data for the five banks is taken from SNL reports.

 

EWBC

HAFC

CATY

BBCN

CWBB

ROAA

1.22%

1.45%

1.24%

1.26%

1.92%

ROE

12.52%

10.44%

8.91%

10.08%

16.66%

Price

36.76

21.45

26.41

14.14

23.50

P/E-trailing

16

16

16

13

9

P/E-forward

15

16

15

13

6

P/B

2.33

1.60

1.34

1.49

1.24

TCE Ratio

8.09%

13.78%

11.11%

11.07%

11.66%

Effic. Ratio

50.94%

56.01%

47.00%

47.16%

46.88%

For comparison purposes, we calculate the Five Bank Average metrics and compare each bank to it. The averages are:

Five Bank Average

   

ROAA

1.42%

ROE

11.72%

P/E-trailing

14

P/E-forward

13

P/B

1.60

TCE Ratio

11.14%

Effic. Ratio

49.60%

Commonwealth Bank: Undervalued Hidden Treasure with 50+% Upside Potential

Commonwealth Bank is on its way to becoming a major player in the Korean American banking space. It recently moved into Center Financial’s offices in downtown Los Angeles Korea Town. Commonwealth provides a complete range of commercial banking products and services to businesses and individuals in the Los Angeles area.

Joanne Kim is the President and Chief Executive Officer of the Commonwealth Bank. Ms. Kim was previously President and Chief Executive Officer of Wilshire State Bank. Prior to that, she served as Senior Vice President and Branch Manager of Hanmi Bank.

I’ve met with Joanne a couple of times over the last year. She sounds very confident about the bank’s prospects. Joanne is a first-class bank CEO and her rolodex is impressive. She knows the Hanmi loan officers and clients well and several of them have been moving from Hanmi to Commonwealth. In our opinion, Hanmi is still struggling and Joanne is exploiting this and picking up market share.

It is Joanne’s intention to build a billion dollar asset bank (this statement was loudly proclaimed at the annual meeting) and she is well on her way. The new location in the heart of Korea town has doubled deposit gathering and loan production since moving into the new space. Joanne expects loans to continue to grow by 17-20 percent per year going forward. This is largely due to Joanne’s contacts – loan growth has doubled because the number of loan officers has doubled – going from 10 to 20. In my opinion, Joanne will continue to take loan officers from her competitors and Commonwealth will continue its stellar growth.

Joanne is working to expand NIM through both reducing expenses and increasing loan interest rates. Expense reduction is being achieved by rolling off CDs with relatively higher earned rates and by an increasing share of demand deposits. Older fixed loans at 4% rates and lower are being replaced by new loans coming on at 4.5-6.0% with a five-year fix term and adjustable thereafter. The bank stated to us that it will not make loans under 4.5% and most of the rates are variable.

Commonwealth recently reported third quarter net income of $2.9 million, or $0.71 per diluted common share.

Ms. Kim stated:

“We are happy to report another quarter of strong financial performance,” said Joanne Kim, President and CEO. “Net income grew 20.9% while pre-tax, pre-provision earnings increased 17.6% during the quarter, driven by strong loan growth, a higher net interest margin and improved operating efficiency. Our net interest margin rose to its highest level this year due primarily to a higher yield on interest-earning assets.”

Commonwealth recently opened its fourth full-service branch in Torrance, CA. In early 2015, they plan to add an additional branch in Orange County.

With this growth record and future potential, we would expect Commonwealth to trade at a premium to its peers. Quite the contrary. Here are the comparables:

 

CWBB

Average

ROAA

1.92%

1.42%

ROE

16.66%

11.72%

P/E-trailing

9

14

P/E-forward

6

13

P/B

1.24

1.60

TCE Ratio

11.66%

11.14%

Effic. Ratio

46.88%

49.60%

Can you see why this has such tremendous upside potential? The 4 Quarter Trailing P/E is 9. The twelve month Forward P/E is 6. On top of that, ROAA is 1.92% and ROAE is 16.66%. Not only does Commonwealth have exceptional growth, but the valuation is extraordinary. How can this situation exist? Because Commonwealth has no Wall Street coverage.

Just like last year, we expect Commonwealth to pay a special 10% stock dividend at year end. The great thing about small banks paying special stock dividends is that after the price is adjusted down for the dividend, it tends to rise back up to the previous stock price level over the next couple of months.

Next up for Commonwealth is a NASDAQ listing. The option has recently been presented to the Board of Directors, and in our opinion, the Board will approve it in early 2015. NASDAQ is important as it will bring analyst coverage to the stock. It will also bring liquidity and will allow bank funds to purchase it. Since bank funds are eager to purchase stocks paying dividends, we believe Commonwealth will institute a dividend once listed.

We suggest investors buy ahead of the NASDAQ listing. We think that just the announcement of the NASDAQ listing moves the bank price to 28 or higher. After it is listed, we expect the primary banking research firms to pick it up. These include Sandler O’Neil, Stifel (who purchased KBW), Raymond James and Fig Partners.

The bank shares will be an easy idea for these firms to bring to their clients given the obvious mismatch in valuation. If Commonwealth traded at the 5-bank average multiple of Forward P/E, the stock would trade at $51. Even if it traded at the 5-bank average multiple of Trailing P/E, it would trade at 37.

Once listed Commonwealth becomes a target for a potential acquirer. It has all of the characteristics a suitor wants – exceptional growth, high quality business, very low valuation, NIM on the verge of expansion and a size that’s easy to digest. Recent M&A activity in this space suggests there should be more to come. Nara merged with Center Financial to create BBCN. WIBC acquired Sayhan Bank last year. If Commonwealth gets a bid, we think it would have to be well north of 35 to be acceptable to the Board.

Cathay Bank: Put it on Your Watch List

Cathay Bank is the oldest Chinese-focused American bank in the U.S. With $11.6 billion in assets, it has more than 50 branches. Branch locations are growing with recent announcements for new ones coming. With a branch in Hong Kong and two representative offices in China, Cathay can achieve better client penetration than many other Chinese American banks with no physical presence outside the U.S.

Financial results at Cathay are on the upswing. In the third quarter, diluted earnings per share increased 18.4% to $0.45, compared to $0.38 per share for the same quarter a year ago. Total loans increased 13.6% annualized, in the third quarter of 2014, to $8.9 billion compared to $8.6 billion at June 30, 2014.

Cathay continues to focus on growing core deposits, and having success. They increased core deposits by $255 million, or 20.9% annualized in the third quarter. Operating expenses were basically flat compared to the second quarter, a sign of increased efficiency. Provision for credit losses was a credit of $5.1 million for the third quarter of 2014 compared to a credit of $3.0 million for the third quarter of 2013.

As it moves forward, I expect Cathay to manage capital more actively. Management has indicated it will focus capital to rebuild the dividend, buy back stock and look at acquisitions.

Cathay’s operating and valuation metrics compare to our Five Bank Average as follows:

 

CATY

Average

ROAA

1.24%

1.42%

ROE

8.91%

11.72%

P/E-trailing

16

14

P/E-forward

15

13

P/B

1.34

1.60

TCE Ratio

11.11%

11.14%

Effic. Ratio

47.00%

49.60%

TCE and Efficiency Ratios are about average. But my concern here is with the profitability metrics. ROAA of 1.24% and ROE of 8.91% are very low, and in my opinion, will hold back stock appreciation in the near term. I expect these metrics to improve over time as Cathay better manages its capital, but it won’t happen overnight. Cathay has good growth prospects but it also has the profitability issue. I think an investor could purchase Cathay as a long-term buy, with an expectation for peer group performance over the short term, or take a wait and see approach with an eye toward buying Cathay down the road when profitability measures improve.

East West Bancorp: Buy on a Pullback

East West Bancorp is the largest bank in our group by far with $26.7 billion in assets. It has more than 120 locations worldwide, with a large footprint in southern California and the Bay area, allowing it to capitalize on the strong California economy. With a number of locations throughout China, it is in the best position to capitalize on the business needs produced by the growth in trade between the U.S. and China. In fact, its name is taken from its goal of serving as the financial bridge between the East and the West.

In the third quarter, net income was $88.8 million or $0.62 per diluted share. The Company increased its third quarter net income by $15.6 million or 21% and earnings per share by $0.09 or 17% from third quarter 2013. Total loans increased $4.0 billion or 23% from third quarter 2013, and total deposits increased to $23.8 billion, up 17% from third quarter 2013. Dominic Ng, the CEO, said:

“Our strong and profitable balance sheet growth has resulted in net interest income of $225.4 million for the third quarter, an increase of $33.0 million or 17% from the prior year period. This is the sixth consecutive quarter we have achieved net interest income growth. Quarter after quarter, year after year, we have consistently achieved superior loan and core deposit growth, resulting in revenue growth. As the financial bridge between the East and the West, we have been able to win new customers, grow our profitability and capitalize on growth opportunities in our markets,”

NIM compression has been an issue in the past, but now seems to have stabilized coming in at 3.44% in the third quarter.

East West compares to our Five Bank Average as follows:

 

EWBC

Average

ROAA

1.22%

1.42%

ROE

12.52%

11.72%

P/E-trailing

16

14

P/E-forward

15

13

P/B

2.33

1.60

TCE Ratio

8.09%

11.14%

Effic. Ratio

50.94%

49.60%

TCE is low at 8.09% and is a concern. Efficiency, ROAA and ROAE are good. P/Es are slightly high, although in all fairness the average P/Es are brought down due to the inclusion of Commonwealth in the group.

I like East West for the size of its footprint throughout California and its dominant position for a domestic bank in China. The long-term growth prospects are excellent. But the TCE and valuation are concerns. It’s arguably fully valued at this level. You could buy a small position here, but I would rather wait for a pullback before jumping in with both feet.

Hanmi Bank: Not Quite Time to Buy

Another Korean American bank, Hanmi has $3.1 billion in assets and 27 branches in California. In the third quarter, Hanmi reported net income of $13.3 million, or $0.41 per diluted share, an increase of 24% over third quarter 2013 net income of $10.4 million, or $0.33 per diluted share.

For the first nine months of 2014, net income increased 18.0% to $35.3 million, or $1.10 per diluted share, compared to $29.9 million, or $0.95 per diluted share, in the first nine months of 2013. On August 31, Hanmi completed its acquisition of Central Bancorp, Inc. (CBI), the parent company of United Central Bank. Mr. C. G. Kum, President and CEO, said:

“I am very pleased with our third quarter results, which reflect strong growth and the initial benefits from our acquisition of Central Bancorp, Inc. Third quarter profitability exceeded expectations with net income up 20.1% from the prior quarter. We also achieved strong organic loan production for the legacy Hanmi Bank, which totaled $169.9 million in the third quarter compared to $115.2 million in the prior quarter. Asset quality continues to improve as both nonperforming loans and classified assets, excluding PCI loans, declined during the quarter. Furthermore, we are making good progress on our ongoing initiatives to increase operating efficiencies and reduce expenses.”

Hanmi is an interesting case study amongst our peer group. It fell from a split-adjusted $180 per share in early 2007 to around $10 in early 2009 – a longer relative fall than any other bank. Since then, the other banks have recuperated, increasing in price many times over – while Hanmi only moved up to the $20-22 level.

Hanmi had put itself up for sale on occasion over the past couple of years, but the attempts failed, apparently for a variety of reasons. I’m sure price was first and foremost. When those efforts did not succeed, Hanmi brought in their new President and CEO. Mr. Kum. I’ve met Mr. Kum a few times. While he has big bank experience, I do not see that he has experience in the Korean American bank space. In fact, I do not believe he even speaks the language. Without this experience, he does not have the business relationships necessary to grow in this sector. In the Korean culture, relationships are important to doing business and they take time to develop. After going through a “transitional period,” where the bank was on the block, and now with a new management team, the environment within Hanmi, and with its clients, may not be the most stable. I know that Commonwealth is gaining market share from previous Hanmi clients, and others may be gaining also. Further, while many on Wall Street seem to believe that a sale is still possible under Mr. Kum, and the bank has publicly declared so, I believe that with the hiring of Mr. Kum that path has been terminated.

Here are the comps:

 

HAFC

Average

ROAA

1.45%

1.42%

ROE

10.44%

11.72%

P/E-trailing

16

14

P/E-forward

16

13

P/B

1.60

1.60

TCE Ratio

13.78%

11.14%

Effic. Ratio

56.01%

49.60%

The efficiency ratio is on the high side, but I’m not too concerned. Otherwise, Hanmi compares pretty evenly with our averages. But, I’m not ready to pull the trigger on Hanmi yet. I think Hanmi still needs to prove itself before I’d buy in. I want to see how the CBI acquisition unfolds first. I want to see stability and a few more quarters of profitability. I would also want to see some consistent growth over some period of time – then I’d be ready to consider buying in.

BBCN Bancorp: Hold or Sell

BBCN Bank is the largest Korean-American bank in the nation with $6.9 billion in total assets. It operates 44 branches in the U.S. along with 5 loan production offices. BBCN has been putting up some impressive numbers. It reported third quarter net income of $21.4 million, or $0.27 per diluted common share as compared to net income of $22.3 million, or $0.28 per diluted common share, for the preceding 2014 second quarter and $23.6 million, or $0.30 per diluted common share, for the year-ago third quarter. Assets, loans and deposits have all increased 7% from January 1, 2014. Kevin S. Kim, Chairman and CEO of BBCN Bancorp, said:

“We had another quarter of consistent execution highlighted by steady loan growth with total new loan originations of $382 million for the quarter. We continue to see good loan demand in our core California and New York/New Jersey markets, while gaining more traction in our newer markets in the Pacific Northwest and Chicago. Despite the ramp up in quarterly loan production, our overall net loan growth for the third quarter was mitigated by a higher-than-usual level of payoffs as result of a few large transactions.

The comps are:

 

BBCN

Average

ROAA

1.26%

1.42%

ROE

10.08%

11.72%

P/E-trailing

13

14

P/E-forward

13

13

P/B

1.49

1.60

TCE Ratio

11.07%

11.14%

Effic. Ratio

47.16%

49.60%

I don’t see much to like here. While I had been excited about BBCN’s potential in the past, it has not been performing recently. Total and per share profits have not grown. The operation metrics don’t look great, with ROAA and ROE below average. Valuation is in line, but in my opinion it should be lower given the performance.

According to TipRanks.com, which measures analysts’ and bloggers’ success rate based on how their calls perform, blogger The Capitalist has a total average return of -2.7% and a 66.7% success rate. The Capitalist is ranked #3046 out of 3393 bloggers.

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