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Why I'm looking to buy regional banks

By Andrew Schornack

The market ran up significantly in the financial services sector over December and January, which has had an impact on the returns of my Financial Services model. Although I see many positions to be undervalued in the long-term, I am beginning to be more cautious on the near-term. Consequently, I raised the cash position in the portfolio.

The top four positions in the portfolio in terms of size as of close on February 11, 2013 are New York Community Bancorp (NYCB), Bank of America (BAC), KKR & Co. (KKR), Cincinnati Financial (CINF), and cash. All firms recently reported earnings that were in line with my expectations and will provide for improved performance and long-term opportunity, in my opinion.

The major change that I had not anticipated in the earnings report but I see as a near-term positive, is the decision by NYCB to re-price $6.0 billion of borrowed funds, resulting in a 117 basis point decline in their weighted average cost.

A near-term challenge for the bank was the cost of their wholesale funding and this action reduced the cost immediately without impairment to capital and extended out the maturity of the deposits.

To illustrate the impact, the 12/31/2012 income statement indicated earnings of $501 million. A 1.16% saving on $6 billion is $70.2 million/year and has no material impact to the rest of the income statement.

NYCB Chart

NYCB data by YCharts

The savings going into 2013 provides a reduced interest expense burden for the business and may provide increased stability in the dividend of the business. I own it for the dividend yield, management, and for what I perceive as a low risk business model.

Looking forward, I am researching buyout targets and accretive acquirers in the regional banking space. Particularly, I am targeting financial institutions between $1 billion and $10 billion in assets that meet the investment guidelines of Covestor.

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