Valley National Geared for Growth: Best in Class

WAYNE, N.J. ( TheStreet) -- When you ask Valley National Bancorp's ( VLY) top executive why the bank avoided risky lending as competitors dove into subprime, his answer is startlingly simple: "We are operating with our own money."

Gerald Lipkin, who has been leading Valley National for 21 years, says he and the rest of the management team are so risk-sensitive because their own financial interests are so closely tied to the bank's health. Lipkin and other current and former directors and executives -- who "still take a very active interest in the bank" -- own upwards of 15% of the company's outstanding shares.

Lipkin and his wife Linda hold over 421,000 common shares between them, according to a recent Form 4 filing, along with options to buy nearly 200,000 more in two-to-eight years' time. Based on the 50-day moving average price of $14.13, the stock alone is worth nearly $6 million. As CEO, chairman and president, Lipkin was awarded a total compensation of $2.2 million in 2008 -- the most recent year for which data are available -- but his base salary was $700,000.

"As a result, we run the bank more as a privately owned company than a publicly owned company," says Lipkin. "We are operating with our own money as opposed to somebody else's money. We tend to be a little more conservative -- we have a zero-tolerance policy for loan losses."

Indeed, Valley National's loan book has performed remarkably well throughout the crisis and its aftermath. Its non-performing assets represent just 1.04% of its $14.3 billion balance sheet. Non-performing loans are under 1% of its entire loan book. That compares quite favorably to NPL ratios of 3% to 7% at banking titans Wells Fargo ( WFC), Bank of America ( BAC), Citigroup ( C) and JPMorgan Chase ( JPM), and less than half the NPL levels of direct regional competitors Hudson City ( HCBK) and New York Community Bancorp ( NYB).

The trend has positioned Valley National to seize opportunities as competitors are still tending to balance-sheet wounds. The bank raised $135 million in private capital through the course of 2009, and paid off the final portion of the Treasury Department's $300 million TARP investment in December. Lipkin says Valley National never really needed bailout funds, but accepted them because being part of TARP was initially viewed as a sign of financial strength. As TARP's reputation changed, and the program became a complicated stigma of sorts, Lipkin was glad to be rid of the funds and their implicit restrictions.

"We didn't need the TARP money and we paid it back," he says. "We look at it as like an insurance policy, but it developed too much baggage. And it was expensive too -- it cost us about 8.5% a year pre-tax."

With a Tier 1 leverage ratio of 7.59% and a risk-based capital ratio above 21%, few would argue that Valley National needs more cash. Now Lipkin's just got to figure out what to do with it.

One option for growth is M&A, and Lipkin says his team is "always out looking to see if there are some smaller, weaker banks that we could perhaps acquire in this environment." However, he also acknowledges that in the relatively resilient New York-metropolitan area, there aren't quite as many opportunities as elsewhere. The Federal Deposit Insurance Corp. has been shuttering banks by the dozen in the struggling Southeast or Western United States, then selling their assets on the cheap. Here, however, it's tough to find a bank in that position, especially one whose loan book is worth buying at any discount, in Lipkin's view.

In the meantime, Valley National management is pushing into fresh commercial lending. Competing banks have been holding back in the commercial space, because of escalating losses on loans made several years prior.

"We are picking up good accounts," says Lipkin.

Lipkin's case for buying Valley National stock is management's conservative underwriting standards -- which never led to heady profits during boom times, but also kept astronomical losses at bay. Valley National remained profitable in each quarter throughout the crisis. Its earning power has been restrained by economic conditions -- with profit dropping from $164 million in 2006, to $96.5 million last year -- but is back on an upward trajectory from the dark days of 2008.

"I think there's a lot of misconception on the Street when people talk about bank lending," Lipkin says. "Banks make their income by making loans. To say that banks don't want to make loans is foolish...The issue is just finding qualified borrowers."

Valley National's share price reflects the company's relative stability and common-sense approach to lending. It has underperformed the broader market, and the iShares Dow Jones US Regional Banks Index Fund ( IAT), since market lows touched a year ago. But Valley National also didn't fall quite as precipitously as other banking peers, especially the large-caps.

Valley National shares touched above $22.80 at the height of the market in October 2008, and eventually tumbled to less than $8.50 last March when bank stocks bottomed out -- a 63% decline. Since then, it has recovered a fair portion of that value, closing last week at $14.40.

Importantly, though, Valley National has maintained a hearty dividend, with a 5.6% yield. Valley has distributed 19 cents per share for the past three quarters, on top of an annual distribution in May. Its quarterly distribution is slightly lower than the 20 cents per share paid out in March 2009, but is still remarkable considering the massive dividend cuts in the financial industry to retain capital against loan losses. Valley National's dividend payout ratio -- the percentage of earnings paid out to shareholders -- has soared from 65.35% in 2007 to 113% last year.

JPMorgan analyst Steven Alexopoulos cited Valley National as a "good dividend play" in a recent note, saying he expects that ratio to remain strong through 2011. Alexopoulos noted that management has been "adamant" in recent meetings that "its shareholders value the dividend and it's a top priority to maintain."

Alexopoulos assesses Valley National's tangible book value at $5.79 per share, with the stock trading at roughly 2.5 times that amount. The average estimate of analysts polled by Thomson Reuters is for the bank to earn 72 cents per share this year, meaning its stock is currently valued at more than 20 times near-term earnings potential.

As a result, Alexopoulos rates Valley National stock underweight noting that it is "the most expensive of all 22 regional banks we cover."

"The company stands out as one of the few dividend plays left in the industry," the analyst said in a recent note. "Beyond the dividend, however, given the steep premium valuation, we see limited room for valuation improvement."

Another concern has been the recent decline in Valley National's net interest margin. Last quarter, NIM dropped 13 basis points to 3.57%, as the company reweighted its portfolio to lower-yielding short-term securities, in anticipation of higher interest rates in the months ahead.

It's unclear how management will make up for that decline in the near-term, unless economic growth picks up dramatically, Valley's commercial loan bets pay off quickly, or attractive M&A opportunities fall from the sky. Yet Lipkin doesn't seem too concerned: "Wider margins isn't the issue," he says. "The issue is just finding qualified borrowers."

At the height of the subprime bubble, Lipkin continued, "analysts kept saying, 'Look at Bank A, B, and C - they're all growing and you're not.' And they were making loans they shouldn't have been making. And then the analysts would say, 'They're all making money and you're not.' Well, they gave all that money back when the loans went bad."

-- Written by Lauren Tara LaCapra in New York

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