Description

Banknorth, a $23 billion (assets) bank holding company based in Portland, Maine, sells for just 10 times earnings despite a good growth record and clean credit profile.

The bank is expected to earn $2.20 per share in 2003. The stock trades at $22 per share. EPS came in at $2.02 for 2002.

Banknorth has the biggest market share of deposits in Maine. It is number 2 in Vermont and New Hampshire. The bank has a smaller presence in Massachusetts, Connecticut, and New York.

Banknorth is acquisitive. They’ve acquired 21 banks in the past seven years. Peoples Heritage Financial Group acquired the original Banknorth in 2000 and took the acquired bank’s name. (Shades of Sandy Weill.)

The loan portfolio is well diversified. The breakdown is 28% consumer finance loans, 28% commercial real estate mortgages, 21% residential real estate, 19% commercial and industrial (C&I), and 5% construction.

The bank is very liquid, with one third of interest earning assets in investment securities. Loans are just 90% of deposits, which means that the bank has lots of room to sell low-yielding investment securities and lend out the proceeds at higher rates. To my knowledge, most banks have loan-to-deposit ratios greater than 110%.

Asset quality is very good, with nonperforming assets just 0.3% of assets at 12/31/02. NPAs have not exceeded 0.7% of assets for more than five years. Loan losses (net chargeoffs) are low, averaging just 0.28% of average loans for 1999-2002.

In my opinion, the most important asset quality measure is how much money a bank has coming in to absorb loan losses. I want a bank to have earnings available for loan losses (pretax profits before loan loss provisions) of at least 300 basis points on average loans. This would mean that a potential net loan loss rate of, say, 75 basis points would be covered four times by earnings. At Banknorth, earnings available for loan losses run at 396 basis points on loans.

The bank has bumped up its return on assets to 150 basis points this year, from 145 basis points in 2001 and 114 basis points in 1997. The top banks in the banking industry have ROAs of about 190 bp. Helping Banknorth’s ROA is the low cost base, with noninterest expenses running at 50-55% of revenue, but this is offset to some extent by a relatively low (340 basis point) spread between cost of funds and asset yields (net interest margin: 400 basis points) attributable mostly to the heavy concentration in low-yielding securities. Most banks have net interest margins of about 450 bp. Banknorth’s cost base is even lower than it appears, because revenue is depressed by the below-average spreads.

Banknorth has little interest rate risk. The bank has structured its maturities such that a 200 basis point decrease in rates would lead to just a 5% decrease in net interest income. A 200 basis point increase in rates would increase NII by 3%.

Banks of this size -- $10 billion to $30 billion -- and market position are prime takeover bait for the big banks. The list of banks of Banknorth’s size that have been subsumed over the past ten years is so long that there’s an air of inevitability to it. I’ll bet that Fleet, as the most probable acquirer, is dying to get its hands on Banknorth, and is willing to pay a multiple in the high teens.

Catalyst

Likely takeover target
Margin Expansion