CapitalSource is a regional bank based in Washington DC. It has recently turned into bank status from a REIT.
OverviewSince CSE’s IPO in 1997, the company has been consistently producing robust returns on equity by their loan services operation. In its earlier years, it has defined a distinct niche in serving health care loans. It has a track record of delivering high level of dividend due to its REIT status, exploiting the tax-favoring structure with REIT.
From 2007, like all other financial institutions, CSE has been beaten down by the financial crisis.
In recent years, the company has started diversifying to other segments outside health care.
They got affected by the residential mortgage.
Balance Sheet
CSE has been trading way below book value for a good while. Based on 3Q09, CSE has equity of $2.4B while it is trading at only around $1.6B market cap. That is easily a 0.6X P/B. That was a steal when it hit $4 in Dec. Currently CSE has been showing an upward trend.
It was a $25 stock back in the peak in 2007.
There has always been an issue in regards to the truthfulness of a bank’s assets. The financial report is just a starting point.
As of my writing, it is trading at about 0.7x P/B which is much lower than many banks that have rebounded since Mar-09’s low. The company has been right to their shareholders and offers tremendous transparency in their disclosures.
If we look at the trend of provision and profitability, it shows a clear trend of residing of net loss and provision for the losses.
We spend of time to look at the risk factors of the bank and asking ourselves what can go wrong.
We put risks to our first and foremost priority for our analysis.
Unlike so many commercial or investment banks today, CapitalSource is a bank with ultra low leverage and an outstanding team of managers who are focused on credit quality analytics for credit decisions, full use of collateral, and conservative lending practices (no 40x leverage and volume at any cost production processes here).
Additionally, this company is currently going through a significant transformation, positioning itself to be both stronger and more profitable in the future.
If you read their report carefully, you can see they have performed a tough stressed test on their legacy loan that shows substantial resilience throughout the financial turmoil in the last couple of years.
On the balance sheet, there is a lot that we can further investigate on a bank’s assets. After a review on their last four quarters reporting 10Q and 10K, after adjusting some of the obvious asset adjustments, taking out
Normalized EarningsAs the banking sector continuously undertaking consolidation…
In case your wondering, I believe that any increase in CSE's funding costs resulting from the current distress within the capital markets should easily be passed on to clients...therefore allowing the company to benefit from increasing yields as competitive pressures decrease (a wonderful combination).
Recent evidence confirms this, as most banks are raising capital for defensive reasons and not making new loans, the result of which has been increasing rates on the loans that CSE provides. A quick perusal of CapitalSource's latest results shows that their loan spreads have recently moved from 300 bps to 800 bps. Considering its low absolute level of leverage, CSE's net margins are all the more impressive.
Access to low cost deposit funding from their recent acquisition of Fremont General should assist in driving profits and shareholder returns going forward as well. The benefits of stability that this cheaper source of funding adds (as bank deposits are far less likely to be pulled away than most alternative sources of short term credit) is a crucial competitive advantage in today's environment. Importantly, over the last few quarter's CSE has shown it's ability to access capital exactly when it is most difficult to do so, and at attractive relative rates...something many financial companies have not been able to do in this environment. In truth, their ability to access capital has been extraordinary. With $5.2B in deposits from the Fremont deal, $365M from their recent secondary offering, $300M expected from the Health Care REIT carveout, $65M from the latest DRIP, and renewing $2.4B worth of credit lines during the summer, this company is looking to deploy lots of capital at very attractive rates.
Conservative leverage, ample capital to deploy profitably in this scarce capital environment, savvy management who knows how to negotiate for value, equity traded for way below the cash value, same for book. The market is jettison anything financial and this baby has been thrown out with the bath water. Sure the debt rating downgrade will make raising new capital more expensive, but CSE does not need new capital and it has a stable deposit base to get cheap capital from. The waiver that started the recent precipitous drop was obtained because of change in circumstance, Wachovia agreed to the waiver because it knows CSE is a good client.
Low debt: They have no debt and in this kind of a market, I really think that is the most important thing going forward. Delaney and crew have also shown that they know how to employ this capital effectively.
Disclosure: Aside from that, I feel that this can be managed if handled properly and this company provide a complete disclosure an any issues leftover from the sub-prime mess.
Taking advantage of Freemonts bankruptcy and horrible financials sector to make a move into the retail banking business.
Has a great healthcare section that comprises 1/3 of the business. Management is aware of the stigma and taking corrective action.
Management
It has a track record of outstanding management that can make deals, taking care of shareholders and being conservative on their lending practises, It has experienced a steady organic growth since XXX… they employ v. low leverage among the other local bank or lending institutions…
CSE has a focus on health care financing sector that has been less impacted by the financial crisis. Like 1/3 of their lending businesses come from the health care financing segment that would has been a less impacted area in the financial crisis.
Even that, they have been hit by the financial crisis.. brought down by the real estate falldown…
Reduced lending competition at a time when demand for their typical loan will increase significantly (as access to capital at economic rates for mid-sized businesses becomes increasingly scarce), should provide management with significant pricing power and improving profitability on new business over the next few years.
In addition, they have been taking advantage of the current meltdown.
ValuationAs CSE's stock price has been taken to the woodshed (along with everything else financial) over the last year or so, savvy investors have an opportunity to buy an above average business at a rock bottom price. I believe CSE is conservatively worth $21, and assuming management executes on their plans to make high return loans on its existing capital (as they have always done) it is worth considerably more. Taking into account that this company continues to make quality loans and good investments, has access to capital during the toughest of times, will have access to demand deposits from it's recent Fremont General acquisition...not to mention it's historically large and growing (going forward) cash generation capabilities today's valuation simply makes no sense. Expect returns of 100%+ over the next 3-5 years.
With a fairly unchanged stable balance sheet and a stock price @ 9.61 CSE has no where to go but up. Hedge funds are currently being ruthless and lowered CSE to an unreasonable low because SEC lost its backbone or (insert your own adjective here) and refuses to enforce current regulations on shorting for everyone but Freddy Mac and Fannie Mae!!!
Buyback: This stock is rising out of the ashes of our real estate meltdown and looking radiant. I LOVE to pick stocks that the company has just done a buyback on, it shows that they are invested in their recovery, long term.
A profitable financial with conservative management, trading at book value and switching from lending on the commercial market to getting liquidity from deposits. What's not to like?
