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Update For Regional Bank Basket Strategy As Of 9/4/15

Sep. 04, 2015 9:07 PM ETTRST4 Comments
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I last updated the regional bank basket strategy here: Update For Regional Bank Basket Strategy As Of 8/21/15 - South Gent | Seeking Alpha

On 6/26/15, the 10 year treasury closed at a 2.49% yield and has trended down since that recent high. The close today was at 2.13%.

Daily Treasury Yield Curve Rates

The net interest margin for banks will remain under pressure for the third quarter, a condition that will most likely continue in the 4th quarter as well.

Net Interest Margin for all U.S. BanksSt. Louis Fed (2.97% 2015 2nd Q)

I sold into the regional bank rally earlier this year due to a number of factors, including a few parabolic prices spikes likely to collapse which later occurred, valuation issues for a few others, and my opinion that the market was seeing Net Interest Margin ("NIM") expansion when I was seeing NIM continuing to contract just by reading an array of earnings reports. I discussed those reasons in my more detail here: Update On Regional Bank Basket Strategy As Of 7/17/15 - South Gent | Seeking Alpha

Consequently, I remain well below my minimum out-of-pocket exposure level of $40K.

I include two ETFs in this basket's table, which I do not own, for comparison purposes. QABA is the closest ETF to my basket. I may start nibbling on some super regionals which would draw me a tad closer to KRE.

First Trust NASDAQ ABA Community Bank Index ETF (QABA)

SPDR S&P Regional Banking ETF (KRE)

With any basket strategy, I want to outperform on a total return basis. I can outperform simply by going down or up more based solely on price.

I also view the difference in yields between my bank stocks in my basket and those ETFs as important. The difference is significant. So, when the price appreciation for an annual period is close to those ETFs, I may outperform solely due to a higher dividend yield.

Last Friday, I outperformed QABA and KRE by going down less. I view that as important as going up more. During periods when regional banks are trashed, going down 15% when the ETF goes down 20% means that the basket can underperform during an up period and still outperform on a multi-year basis.

The same kind of idea is expressed in my current overall risk management in this post: Stocks, Bonds & Politics: Portfolio Management Goals-Snapshots of Performance Numbers YTD, 3 and 5 Years Cumulative

Regional Bank Basket as of 9/4/15

My unrealized gain decreased by about $920 since my 8/21/15 update. I have pared this basket significantly YTD prior to that last update.

I am not tracking reinvested dividends in this table. Carter Bank & Trust (CARE) has a dividend yield over 3%, but YF currently does not reflect that fact. CARE was a recent add discussed here: Update For Regional Bank Basket Strategy As Of 8/7/15 - South Gent | Seeking Alpha

The dividend yield shown in the preceding table is calculated by Yahoo Finance based on today's closing prices. The dividend yield at my total average cost per share will be different. I currently have two banks in the basket that yield over 8% at my constant cost numbers (WASH and NYCB) and a few others that are over 5%.

I have had only one trade since my last update, which is discussed in Item #2 below.

My net realized gain in this basket strategy currently stands at $22,748.96 REGIONAL BANK BASKET STRATEGY GATEWAY POST Snapshots of round trip trades can be found at the end of that post. This basket has generated an annual average $1,917 in dividends over the past 3 years.

Regional banks performed better today then REITs even though interest rates went down some.

Closing Prices 9/4/15:

DJIA: 16,102.38 -272.38 (-1.66%)

S & P 500: 1,921.22 -29.91 (-1.53%)

VIX: 27.80 +2.19 (+8.55%) : VOLATILITY S&P 500

TLT: $122.68 +1.11 (+0.91%) : iShares 20+ Year Treasury Bond ETF

IEF: $106.97 +0.33 (+0.31%) : iShares 7-10 Year Treasury Bond ETF

LQD: $116.06 +0.26 (+0.22%) : iShares Investment Grade Corporate Bond ETF

MUB: $109.00 +0.12 (+0.11%) : iShares National AMT-Free Municipal Bond ETF

QABA: $36.95 -0.24 (-0.65%) : First Trust NASDAQ ABA Community Bank ETF

VNQ: $72.20 -1.37 (-1.86%) : Vanguard REIT ETF

1. FirstMerit (FMER): FirstMerit "increased" its quarterly dividend from $.16 to $.17.

In 2009, FMER slashed its quarterly dividend rate in stages from $.2858 to $.16 effective for the 2009 4th quarter. The new $.17 quarter rate is the first increase in almost 6 years after that slash.

When and if FMER increases the penny rate above $.2858, then I will call that raise a dividend increase.

My first foray into FMER stock occurred after the Board slashed the dividend. I have been selling my highest cost shares profitably and have consequently reduced my average cost per share to $14.55. (snapshot at Regional Bank Basket Update as of 1/2/15).

The market reacted negatively to FMER's second quarter earnings report, as I noted in a prior comment which I will drag and drop here:

Start of Quote:

"FMER's report was a slight disappointment to me, and the stock fell 6% to close at $18.96.

E.P.S. was $.33 vs. $.35 in the 2014 second quarter and 1 cent below the consensus estimate.

FirstMerit Reports Second Quarter 2015 EPS of $0.33 Per Share

FMER is one of my larger banks, where institutional investors dominate trading and they will frequently stampede together toward a narrow exit door based on slight disappointments that mean nothing long term.

My cost basis is $14.55 per share, and see no reason to sell at today's closing price.

Some of the numbers were fine:

Average total loans to deposits 79.06%
Net charge-offs to average loans ratio 0.20%
NPAs to loans and other real estate 0.87%
Period end tangible common equity to assets (1) 8.09%

Return on Assets and Return on Equity were below 1% and 10% respectively:

Return on average assets (ROA) 0.90%
Return on average equity (ROE) 7.85%
Return on average tangible common equity 11.44%

The efficiency ratio is neither good or bad at 62.37% but is ticking up which is not good.

NIM continues to decline, falling to 3.39% from 3.75% in the 2014 second quarter and that probably caused a lot of the selling. Part of the problem is the gradual loss of interest income due to accretion from acquired loans. So, the earlier numbers from last year and the previous year were juiced due to that accounting convention. That probably surprised a lot of institutional investors. I have discussed the accounting accretion juice in the blog for about 2 years. A story appeared in Barron's back in March 2014 on the subject:

"Regional Banks That Face EPS Headwinds"

End of Quote

Sourced: My comment dated 7/28/15 to this post: Update On Regional Bank Basket Strategy As Of 7/17/15 - South Gent

A one year chart reveals the current level of dissatisfaction with this bank: FMER Interactive Stock Chart

I have quit reinvesting the dividend and may only buy a 50 share lot when and if I can lower my $14.55 average cost per share.

I may sell the position. If I continue to hold, I am not likely to start reinvesting the dividend until both regional banks and FMER are in bear markets. In other words, I am sufficiently dissatisfied that I would prefer having the dividend in cash, which I can then aggregate with other cash dividend and interest payments to buy an income producing security other than FMER's stock.

2. Bought 100 TRST at $5.9:

Trustco is a holding company for TrustCo Bank that has 146 branch offices located in New York and Florida.

The stock went ex dividend for its quarterly dividend after my purchase. TrustCo Declares Cash Dividend

Trade Snapshot:

Dividend Yield: TRST is currently paying a quarterly dividend of $.065625 or $.262 annually.

Assuming a continuation of that rate and a total cost per share of $5.9, the dividend yield is about 4.44%.

For those readers following my regional bank basket strategy over the years, TrustCo would be a familiar name. I have bought and sold it several times.

I last liquidated my position by selling 315+ shares at $6.92: Sold 315+ TRST at $6.92 (1/11/15 Post)(profit snapshot=$549.97);Sold 308 TRST at $6.64 (10/28/13 Post)(profit snapshot +$238.38); Sold 50 TRST at $7.29 (11/25/13 Post)(+32.67)

Total Realized Trading Gains: $819.33

Given my last purchase was at $5.9 and I only bought 100 shares, the natural question to ask is what happened?

Certainly, nothing good has happened to TrustCo shareholders since January 2015 when I sold 315+ shares at $6.92.

The problem arose when TrustCo announced its second quarter earnings.

The earnings were okay, but the bank announced that its regulator found issues in need of repair that would cost an annual estimated $2.5 to $5M to fix according to TRST. The after tax impact on net income would be less depending on TRST's tax rate. In addition to the after tax impact on net income, the market is assuming that the additional annual costs can not be offset, at least in part, by cutting operating costs elsewhere.

This is an excerpt for that press release which merely alludes to this problem without providing much in the way of details:

In the conference call, TRST was suggesting that the regulator was over zealous, which may be the case, but that explanation still sounded like spin to me.

The stock declined in response to this problem falling from $6.81 (7/22/15) to $6.41 (7/23) and then to $6.19 (7/24). Volume was unusually heavy.

The stock later drifted down to around $6.05 before the latest stock market meltdown that knocked the price to an intra-day low of $5.59 (8/24) before recovering some thereafter. TRST Historical Prices

I would estimate that this annualized additional cost issue has cut the price from $6.81 to $6.05 or $.76 per share, with the market meltdown contributing to the remaining decline.

When I multiply $.76 by the number of shares outstanding as of 6/30/15 which was 95.132M, the net market capitalization lost was about $72.3 million for an annualized increased expenditure between $2.5 to $5m, assuming TRST's management is being forthcoming in its future estimates.

The earnings were in line with expectations.

The 2014 second GAAP net income was juiced by an extraordinary gain resulting from the sale of a building.

The financial metrics were not that much different from previous reports.

The NPL ratio is trending down and that is a good thing. The coverage ratio is trending up and I like that reserves for potential loan losses are 1.41 times NPLs prior to my repurchase. The charge-off ratio is good at .15%.

This snapshot captures mostly performance ratios for the Q/E 6/30/15, 3/31/15 and 6/30/14 moving from left to right:

Those trends are slightly negative with ROA and ROE declining some. The efficiency ratio is good at 54.71%.

Tangible book value per share was $4.23 as of 6/30/15.

Overall, this is a lackluster bank that chugs along and needs to be acquired by a larger institution who could then allow TRST's CEO to retire after his many years of service.

TrustCo's heyday was between November 1990 to November 2004 when the stock went from about $2 to $14: TRST Interactive Stock Chart

With the new additional expenses in the works, the two analysts providing E.P.S. estimates predict $.43 per share in both 2015 and 2016. TRST Analyst Estimates Even without those additional expenses, investors have had a hard time warming to TRST for a decade or so. The only cure IMO is for a larger bank to acquire TRST and then allow TRST's executives the opportunity to spend more time with their families.

I will consider averaging down at less than $5.

Disclaimer: I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals and situational risks. I can only make that kind of assessment for myself and family members.

Analyst's Disclosure: I am/we are long TRST.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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