Bottom of the Barrel: Rising Tide at Coastal

Houston-based Coastal Bancorp CBSA may be a name you can take to the bank.

This $3 billion Texas savings bank is in the process of morphing from a sleepy savings and loan approach to a commercial bank focus to improve returns.

The transformation is well under way: In November, the company announced a sale of $850 million of illiquid mortgage-backed securities highly sensitive to interest rates. With the proceeds, Coastal bought $513.6 million of mortgage-backed securities with slightly lower yields but less interest-rate risk. Of the proceeds, $304 million was used to pay down liabilities and an additional $44 million will be used to redeem 10% senior notes in February.

"The sale is likely to be a short-term negative to earnings as timing of the reinvestment of the proceeds is not immediate," says banking analyst Jennifer Demba of SunTrust Robinson Humphrey. "However, the sale should be a long-term positive for Coastal as the new assets will be less subject to interest-rate fluctuations. Although the average yield on these assets will be lower than the prior portfolio, the pay downs should occur sooner and the assets can be replaced with higher-yielding assets as rates rise." Demba rates the stock buy, and her firm has not provided banking services to Coastal.

At a Glance Coastal Bancorp (CBSA:Nasdaq)
Current Price	$28.00
52-week Range	$21.87-$40.00
Price-Earnings Ratio	8.51
Market Cap	$163.3 million
Avg. Daily Volume	19,136
Inst. Ownership	63%
Dividend Yield	1.74%
Beta	0.8
Company Web site	www.coastalbanc.com
Source: Market Guide, Zacks, company reports

Coastal indicated the sale will result in lower earnings in the fourth quarter and into 2002. The bank says 2002 earnings will be $2.75 to $2.90 per share vs. previous estimates of $3.70. Coastal's 2002 asset base will drop to $2.5 billion from about $3 billion.

The portfolio transformation, combined with general weakness in thrifts and with concerns about the Texas economy, has pushed Coastal stock lower. Since mid-September, the stock has dropped nearly 25%. And, while the unraveling of Enron ENE creates some economic risk to the Houston economy -- Coastal has no direct lending exposure to Enron -- the recent weakness in the bank's stock appears to create a real opportunity.

"Even with the decrease in earnings estimates, Coastal trades at a very attractive valuation of 10 times our 2002 estimates and 1.4 times book value," says Demba.

Attractively Refocused

The asset transformation, which began slowly five years ago, is reaping rewards. Coastal's net interest margin has increased from 1.78% in 1995 to 2.95% today. The bank can now grow its commercial portfolio with little additional cost.

As a result, while the restructuring will affect earnings in 2002, margins will improve, which will boost the bottom line over time. "Coastal's margins should continue to improve as it makes higher-yielding commercial loans and focuses on gathering more lower-cost deposits from its commercial clients," says Demba.

What's more, the transformation creates a more robust portfolio as interest rates begin to rise. "This moves Coastal from a liability-sensitive institution to an asset-sensitive institution," Demba says. "Because asset-sensitive institutions benefit in a rising interest-rate environment, Coastal is well-positioned if interest rates rise, as we believe they will in the second half of 2002."

There is one other potential benefit to shareholders of the new commercial focus: It turns Coastal into an appealing takeover candidate. With 50 branches in attractive Texas markets -- Houston, Austin, Corpus Christi and the Rio Grande Valley -- Coastal is the fourth-largest independent financial institution in Texas. And, with both Texas banks and those outside the state looking to gain market share, especially in the Houston and south Texas markets, Coastal will receive its share of interest.

Banking Profits Can the tide rise at Coastal?
Year	Revenue	EPS
1998	$210.80	$2.16
1999	202.9	1.42
2000	237.5	2.87
2001*	223.3	3.18
2002*	231.6	2.75
*Estimates. Source: MarketGuide, SunTrust Robinson Humphrey, company reports, TSC Research

While Demba's 12-month price target is $33, she believes investors would be more handsomely rewarded in a takeover. "Based on a deposit premium of 15%, we believe Coastal's estimated take-out value could be more than $40 per share," she says.

Coastal has risks: Lower year-over-year earnings have not been well-received by investors. Plus, if interest rates continue to decline, earnings could feel the pinch. In addition, even though the bank has no direct exposure to Enron, the Houston economy will feel the impact of its meltdown, as could Coastal.

Still, Coastal management's strategy looks good, and the timing of the transformation is near-perfect. And, with the possibility of suitors in waiting, patient investors will be rewarded.

While the uncertainty of knowing how Coastal will perform in its new environment knocks a half-barrel off our rating, we think Coastal is a nice small-cap bank to have in the portfolio. We give it 2.5 barrels.

For an explanation of our barrel rating system, see our recent description.

Goody's Two Shoes Drop

Looking back at previous barrel picks, we note that our most recent profile, which suggested you avoid Goody's Family Clothing GDYS, proved prescient -- the stock is off nearly 21% since Nov. 28.

On Dec. 6, the company announced that same-store sales dropped 18% in November and warned that December sales were on track to be lower than last year. The company also warned that fourth-quarter profits may be lower than last year.

Stocking Stuffers A barrel that's at least half full!
Barrels	Company/Ticker	Date of Mention	Mention Price*	Current Price	% Change
	Goody's Family Clothing (GDYS:Nasdaq)	28-Nov	$4.50	$3.56	-20.89%
	VitalWorks (VWKS:Nasdaq)	21-Nov	4.30	5.45	26.74
	FPIC Insurance (FPIC:Nasdaq)	14-Nov	12.83	13.67	6.55
	Coinstar (CSTR:Nasdaq)	7-Nov	19.96	24.54	22.95
	Witness Systems (WITS:Nasdaq)	31-Oct	8.06	12.37	53.47
	Hibbett Sporting Goods (HIBB:Nasdaq)	24-Oct	30.33	26.65	-12.13
	Met-Pro (MPR:NYSE)	17-Oct	11.16	12.40	11.11
	Bridgford Foods (BRID:Nasdaq)	10-Oct	13.18	13.00	-1.37
	Quixote (QUIX:Nasdaq)	3-Oct	21.44	21.15	-1.35
*Average price on date of mention. Source: TSC Research

There has been little news from the balance of the names we have profiled. As we've said recently, if you have gains in VitalWorks VWKS, Coinstar CSTR and Witness Systems WITS, there is nothing wrong with booking profits. And, while we still believe in Hibbett Sporting Goods HIBB, our patience will run out if we don't see good numbers in the Christmas season. The sale of shares by a large shareholder continues to be the primary overhang.

Check back here for continued reviews on the stocks profiled in Bottom of the Barrel.

Do you have candidates for Bottom of the Barrel? If so, shoot me an email with the company name, why you think it qualifies and your full name and hometown. If we profile your suggestion, we'll send you a TSC gift to commemorate your pick.