Northway Financial: A Promising Bank Trading At A Discount

| About: Northway Financial, (NWYF)


Growing income from core assets helps to position for growth.

The market is not adequately valuing the growth potential of Northway.

Northway's loan portfolio growth has the potential to provide significant long term returns to investors.

Investing in small banks can be an inherently risky business. Trying to pick the small banks that will be able to survive in a rather sluggish economy is risky. However, I believe that there is still significant value within the banking sector as a whole that is underutilized especially amongst banks that would be considered to have a small or medium sized market cap. I believe that one such bank is Northway Financial, Inc (OTCQB:NWYF). Northway is a small bank that is trading at a substantial discount for long term oriented investors. The bank is growing net income, lowering its efficiency ratio, is trading at a low Price to Earnings ratio versus peers and on top of that is paying a dividend to shareholders. Northway has many positive events that have taken place and is on a track towards sustainable growth and capturing more of the New Hampshire banking market.

Growth Opportunities

Investors always need to be careful when evaluating the growth prospects of various companies. We need to make sure that they are not growing too fast, and as investors we need to make sure that our companies are seeing the expected Return on Investment (NYSE:ROI) that we would typically expect due to the growth strategy. With this in mind, lets turn specifically towards Northway.

Northway has been growing at a very sustainable pace over the last few years. They have not been too flashy, or very quick, about opening up new locations. They recently opened up two new locations, the first being in Manchester and the second in Portsmouth. These new branches should help to increase the bank's marketshare and fits quite nicely with the geographic distribution of Northway's current locations. These branches become more important though, when investors realize that these are Northway's first forays into Southern New Hampshire. The performance of these branches will be critical to Northway's future, and will help for Northway to access markets where they were previously not able to compete. Even more importantly though, it helps to show that Northway is committed to growth, but to doing so at a sustainable pace. As investors we want to make sure that a company is not going to grow too fast and outstrip its resources. With this in mind, we need to take a look at the financial resources for the company in order to insure that Northway will not be outstripping its resources and that Northway provides a solid value proposition for investors.


The financial situation of any bank must be carefully analyzed in order to make a good investment decision. As long term oriented investors we need to make sure that we invest in a company that is health financially, and that we believe will be around for a long time. Especially when looking at small cap banks investors need to tread lightly and look for growth in a variety of areas.

First of all, there was a decrease in the net income when compared to the first quarter of 2013. The difference is due to a gain on securities in the first quarter of 2013 of approximately 1.6 million dollars. If you subtract out the gains on securities for both quarters, you realize that Northway has seen promising growth in its net income. The reported net income for Northway for the first quarter of 2014 was $1.3 million dollars. Which although it was down from 1Q 2013, $2.0 million in net income, if we subtract out the gain in securities we can see that the overall net income for the core operations of the bank does appear to be growing. This is significant as the core operations will be what helps to drive value for the bank over the long term and will help to make sure that the company is financially stable heading into the future. Yes, gains in securities are nice because they help to make the bank look better but through digging deeper we realize that the bank is better positioned now than it was in the first quarter of 2013 for net income growth.

When looking at the tangible book value per share, we also realize that Northway is looking like it may still have room to grow. The tangible book value per share grew to $17.89. With the company trading at $18.71 per share, this would suggest that the market is barely valuing Northway over its tangible book per share. Through not valuing the company higher it would appear as though the market has substantially undervalued the future growth of the company. With its recent expansion into New Hampshire, along with solid loan portfolio growth Northway should be trading at a higher premium.

Another indicator of health would be whether or not the company can afford to pay dividends to its investors. One of the most interesting things regarding Northway is the fact that it pays a semi-annual dividend to its investors, most recently this dividend was $0.32 which means that if the company holds the dividend steady, that investors should expect to see approximately $0.64 per share in dividends. This helps to cushion any possible downtrend in the shareprice and should help the long term oriented investor who is interested in the company.

Finally, it is important to note that Northway has been decreasing its provision for loan losses. Northway was able to reduce its provision for loan losses over the previous year by $515,000. This is significant as it would suggest that there is growing confidence in the quality of the loans in Northway's portfolio. This would also suggest that Northway's portfolio has turned a corner and that Northway no longer expects to see substantial losses related to bad loans. What is even more significant is that the company has been lowering its provisions for loan losses while experiencing substantial growth in its loan portfolio.

Loan Growth

With the decrease in the amount of bad loan provisions, we as investors do, however, need to make sure that the company is still showing significant growth in its loan portfolio. If the company is not showing any sort of growth this would be a bearish indicator as the company is likely sacrificing long term growth by not making more high-quality loans which will reduce their interest income over the long term.

Northway has managed to along with its growth in Southern New Hampshire, to continue to grow its loan portfolio. Northway was able to increase its net loans by $53 million, or 9.3% compared to last quarter. Of this loan growth $45 million was in commercial loans, and commercial loans now make up over 62% of Northway's loan portfolio. The total loan portfolio is at $625 million. This large of a loan portfolio should help to provide stable interest income for the company.

Commercial loans can be risky, however, they can also be viewed as essentially a bet on the overall conditions within New Hampshire. Should the conditions stay the same or improve, we should see a lower default rate amongst commercial loans and therefore, it would appear as though Northway is strategically positioned for growth heading into any sort of economic growth in New Hampshire. Commercial loans are inherently risky, and it is something that an investor is going to have to weight into their investment decision. Commercial loans have the ability to provide substantial returns for investors if the companies that took out the loans are able to succeed. While I would have liked to see more diversity amongst Northway's loan portfolio, the fact that it is based mostly on commercial loans could be an asset or a liability. I personally am bullish on the economic situation in New Hampshire, and therefore do not mind seeing a large percentage of the loan portfolio of Northway directed towards commercial lending.

Bear Case

While I, as you might imagine, am a bull on the company; there are some interesting points that can be made on the bear side of the case. The first, and most obvious, downside would be that the commercial loan portfolio exposes the company to unnecessary downside. Having a relative lack of diversity in its loan portfolio means that should the commercial sector implode, it looks as though the company would be subject to significant downsides.

Another bear case would be that the company is expanding too quickly and outstripping its resources. With the rapid expansion into Southern New Hampshire the company could be trying to reach too many markets at once.

As I discussed above, I do not believe in any of these bear cases, however, for the sake of balance in the article they have been included.


Northway offers a substantial value proposition for investors. Its net income from core operations has been growing, and the company is well positioned to take advantage of a rapidly growing loan portfolio. It appears as though Northway is undervalued relative to the long term growth potential of the company. Northway has been expanding into Southern New Hampshire, which should help to provide additional growth opportunities for long term oriented investors. Overall it appears as though Northway is undervalued relative to where it should be and it appears as though Northway is set up to provide significant returns to its investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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