Description
|
Ticker: |
UCBH |
|
Date: |
3/23/07 |
|
Price: |
$18.50 |
|
Position: |
Short |
|
Target Price: |
$14.50 |
|
52-wk high |
$20.19 |
|
52-week low |
$15.55 |
|
S/O |
99.5M |
|
Last 12-mos EPS |
$1.03 |
|
Last 12-mos Revs |
$312M |
Short Idea: UCBH Holdings (UCBH)
$1.8B market cap California state-chartered commercial bank
Executive Summary:
UCBH is the leading Chinese-American bank in the Bay Area. Historically, the company has been an impressive grower with 5-yr core earnings CAGR over 15%, and loan and deposit CAGR over 20%. A key piece to their growth strategy has been acquisitions, which now includes expansion into China. The Company’s original mission was to capitalize on the ethnic Chinese population in CA. This focus was advantageous for UCBH for a couple of reasons: 1) Chinese population was rapidly growing and underserved; 2) cultural inclination to save and repay outstanding debts. However, fast forwarding to the present day, we find the ethnic Chinese market is saturated, and UCBH’s B/S is comprised primarily of CDs funding loans to non-East Asian ethnic Americans (who are not averse to turning in the keys to the bank when the going gets tough). In addition, in an attempt to sustain the earnings treadmill, they have sacrificed earnings quality and increased credit risk. The answer they believe lies in expanding to China, but that is a highly risky proposition with little economic benefit until beyond 2010.
Investment Thesis: The short call on UCBH is based on: 1) credit deterioration in the construction portfolio; 2) earnings miss in Q1 due primarily to NIM contraction; 3) decreasing earnings quality; and 4) possible actions by regulators as they are in violation of the CRE lending guidelines.
- Construction Portfolio: UCBH has grown their construction portfolio aggressively over the past 12-months (see below) at allegedly the most risky period for housing since the early 90’s. Almost the entire construction loan book is based in CA, with approximately 75% representing primarily 1-4 single family development loans which I believe to be high risk. In addition, the remaining 25% is even higher risk as it is comprised of 5% land financing and 15-20% of condo development. In addition to the ill-timed aggressive growth, geographical concentration, and composition of the loan book, comments by Mike Perry, CEO of NDE (CA mortgage/construction Loan lender) supports the thesis of deterioration going forward.
- Mike Perry of NDE “We have some large credits (in $30-$40M range) to builders that could become non-performing…..so we think likely that our builder credit will deteriorate going forward.
Exhibit 1:
|
|
2005 |
2006 |
Growth |
|
UCBH Loan Book |
$5,839.0 |
$6,636.0 |
14% |
|
Construction Book |
$467.1 |
$1,061.8 |
127% |
|
% of Loan Book |
8% |
16% |
|
Exhibit 2:
|
Construction Loans as |
1Q04 |
2Q04 |
3Q04 |
4Q04 |
1Q05 |
2Q05 |
3Q05 |
4Q05 |
1Q06 |
2Q06 |
3Q06 |
4Q06 |
|
% of Tangible Equity |
75% |
75% |
75% |
75% |
75% |
77% |
77% |
100% |
120% |
130% |
155% |
200% |
- Earnings Miss in Q1: I think the company reports $.24 in Q1 vs. consensus of $.26. The shortfall is going to come primarily from NIM contraction, and secondarily from lower sales of CRE/multifamily. In addition, this could be the quarter where we begin to see credit deterioration, specifically in the construction book.
- NIM – the company levered up the B/S with $800M of investment securities at 12/31/06 (24% securities/assets). The Company should feel the full brunt of the leveraging of the securities book in Q1, which is a much lower yielding asset. Consensus is roughly 3.21%, which is down from 3.34% in Q406, but I believe that it will be 3.12%. Every 10 bps of margin compression is roughly $.02 of earnings.
Exhibit 3:
|
RATE |
4Q06 |
1Q07 |
|
|
|
|
|
Loans |
7.67% |
7.8% |
|
Securities |
5.12% |
5.12% |
|
Other |
5.24% |
5.24% |
|
|
|
|
|
Total int. earning assets |
7.04% |
7.03% |
|
|
|
|
|
NOW, Checking and mmkt |
3.53% |
3.63% |
|
Savings accounts |
1.60% |
1.65% |
|
Time deposits |
4.82% |
5.12% |
|
Total int-bearing deposits |
4.13% |
4.28% |
|
|
|
|
|
Borrowings |
4.53% |
4.90% |
|
Subordinated debentures |
8.09% |
8.09% |
|
Total borrowings |
4.94% |
5.29% |
|
|
|
|
|
Total int-bearing liabilities |
4.29% |
4.51% |
|
|
|
|
|
Net Interest Margin |
3.265% |
3.051% |
|
FTE NIM |
3.34% |
3.12% |
- Sale of Multifamily/CRE – the company has been selling about $4M per qtr, but now intends to sell about $1.5M per qtr. The street is roughly at $2.5M for Q1. $1M is equal to about $.005.
Exhibit 4:
|
|
FBR |
KBW |
LEH |
Opp |
Mean |
Chaney |
Q406 |
|
NIM |
3.24% |
3.13% |
3.20% |
3.25% |
3.21% |
3.12% |
3.34% |
|
NII |
$77.6 |
$78.3 |
$77.0 |
$68.4 |
$75.3 |
$73.0 |
$66.2 |
|
Loan Sale Income |
$1.8 |
$4.0 |
$1.8 |
$2.0 |
$2.4 |
$1.5 |
$4.5 |
|
Non-int income |
$11.1 |
$12.5 |
$9.5 |
$10.0 |
$10.8 |
$10.7 |
$12.0 |
|
Expense |
$42.9 |
$44.6 |
$43.4 |
$39.0 |
$42.5 |
$43.6 |
$38.1 |
|
Provision |
$3.0 |
$3.7 |
$2.8 |
$4.0 |
$3.4 |
$4.3 |
$1.4 |
|
|
|
|
|
|
|
|
|
|
Loan Growth |
10% |
16.8% |
13.4% |
18% |
15% |
15% |
5% |
- Quality of Earnings is Low: Aside from the fact that the company has been gunning the construction portfolio at the peak of the housing market, UCBH has generated low-quality earnings due to a change in their reserve methodology. The company earned $1.03 last year, and $.12 (11.5%) was from the change in reserve methodology. In addition, the company generated an additional $.12 (11.5%) from the sale of multifamily/CRE loans from their B/S.
- In Violation of The Regulatory Guidelines Re: CRE Concentration: Early last year the regulatory agencies issued guidelines regarding CRE concentrations as an increasing number of banks had become more vulnerable to the cyclical CRE markets. The two guidelines that dictate the prudent threshold for banks are as follows:
1. Total Reported loans for construction, land development, and other land represent 100% or more of the institution’s total capital; or
2. Total reported loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development, and other land represent 300% or more of the institution’s total capital.
Per UCBH’s most recent Call Report, they are in violation of both guidelines as demonstrated below:
Exhibit 5:
|
Guideline Proposal |
Agencies Recommended Level |
UCBH Actual Level |
|
1 |
100% |
126% |
|
2 |
300% |
568% |
- Primary Risk: The primary risk of being short is the announcement of the China bank acquisition. It is clear that they have done due diligence on at least two banks, and mgt is confident that they will get an Rmb denominated banking license by year-end (and therefore this is partially baked in at this price level) – the uncertainty is the timing. Since the company was optimistic last year, and then failed to obtain the license because a new Chinese Regulator was appointed, mgt is a little gun shy. What we do know is that Mgt will not make an announcement until they have full approval from the Chinese regulators. This is why I believe it could be a 2H07 vs. 1H07 event as there are a number of obstacles that will most likely arise through the political process for approval.
For at least the next few years, the China story will be more about sentiment than returns. The company expects it will generate about $80M in loans in ’08 and $100M in ’09, and will progress very “cautiously”. Accordingly, if the stock spikes on such an announcement, then it would be an opportune time to press the short. Below is a rough idea of the contribution from China given the expected ramp in conjunction with the average Chinese Bank’s ROA.
Exhibit 6:
|
|
2008 |
2009 |
2010 |
|
Earning Assets |
$80,000.0 |
$100,000.0 |
$120,000.0 |
|
ROA |
0.50% |
0.50% |
0.50% |
|
Net Income |
$400.0 |
$500.0 |
$600.0 |
|
S/O |
99500 |
99,500 |
99,500 |
|
EPS |
$0.00 |
$0.01 |
$0.01 |
|
Stock Price |
$18.50 |
|
P/E |
15.9x |
|
Yield |
0.60% |
|
Book Value |
$7.90 |
|
P/B |
2.4x |
|
Tangible Book |
$5.33 |
|
P/TB |
3.5x |
|
ROE |
15.5% |
|
SI |
10.6% |
If the company gets a credit hiccup and investors become concerned over the construction portfolio, then I think the stock could go to $14-$15, which is 12.7x ’07 consensus (but estimates probably closer to $1.05 or lower if credit deteriorates – aver. construction loan is $1.8M, and every $1M NCO equates to about $.01), 1.9x book, and 2.8x tangible book. Conversely, the upside could be in the $21-$22 range based on the China bank acquisition announcement. So let’s suppose sentiment drives the stock to the midpoint of that range, i.e., $21.50, then the stock would be trading at 13.8x my ’07 estimate, and 350 times the China contribution for the next three years (being generous and not discounting back the out years contribution). Accordingly, this irrational reaction would be a good opportunity to press the short position.
Catalyst
Q1 Earnings;
Deterioration of Credit;
Regulatory enforcement of CRE guidelines.