Money and Investing Thoughts

City Bank (CTBK: 0.00 N/A N/A) of Lynnwood, WA released their 2nd quarter earnings today, and they were not pretty. They took a large charge off and a significant portion of their loan portfolio is nonperforming. Here are a few of the pertinent figures compared to the 2nd quarter of 2007.

• Net earnings of $5.3 million vs. $10.5 million, the difference can be accounted for mainly by the $4.4 million increase in loan loss reserves and $1.8 million in charge offs.
• Net per share of 34¢ vs. 67¢.
• Non-performing loans of $63 million vs. just under $2 million one year ago.
• Foreclosed assets of $40 million vs. none a year ago.
• Non-performing loans are 8.0% of assets vs. 0.18%.

City Bank’s main business is residential construction loans and it is obvious the company has a lot (8%!!) of assets in that area that are in trouble. The slowdown in residential housing construction definitely hits this bank where it hurts the most.

On the positive side, the City Bank predicts it will remain profitable, though reduced from previous years. The 15¢ per quarter dividend should be safe. Loan loss reserves now total about $15 million, which appears adequate and their Tier 1 capital ratio of 17% is well above the 4% minimum.

At this point the question for me is how long will it take the bank to work out it’s problem loans? If earnings are another 60¢ per share for the remaining half of the year the PE and yield are still around 6 at a $10 share price. Not bad valuations if this is the worst, however at this time I think it will take several quarters to work out the problems. I believe that City Bank has excellent management, but current economic conditions are working against a speedy recovery.

On Monday I plan to reduce my holdings in CTBK by about 2/3.

I hate to do this but I feel a bit good about the fact that the Ultrashort Financials ProShares (SKF: 47.10 0.00 0.00%) has dropped by 35% since Tuesday. This ETF is designed to give twice the gain as the loss of the Financial Select Sector SPDR (XLF: 14.665 0.00 0.00%). Also, double the losses if XLF rises.

Over the past couple of months I have believed the share prices of many good financial institutions have been driven down to stupid levels. At the same time my reading of comments at online articles about financial stocks showed a tremendous level of belief that the U.S. financial system and companies were in a death spiral. I hope some of those naysayers were among those who bought 35 million shares of SKF on Tuesday and now have lost a third of their investment.

I understand the beliefs of both bulls and bears, and readers here know I am pretty much of a perma-bull on the stocks I like. I have no sympathy for those who take a double exposure bet against a big part of the U.S. economy hoping the sector collapses. So here is hoping for continued gains for my financial sector picks: (CTBK: 0.00 N/A N/A) and (AYR: 14.14 0.00 0.00%) and I hope XLF doubles from here and SKF goes to $0. Can that happen? I don’t have a clue.

Note: I have long positions in CTBK and AYR.

What would you think of a stock that had the following characteristics:

• Current yield: 7.7%
• No dividend quirks: Not a LP, MLP or foreign stock with withholding rules.
• Steady dividend growth: 2004: $1.55 per share, 2005: $2.00 per share, 2006: $2.09 per share, 2007: $2.20 per share and a minimum of $2.27 for 2008.
• The quarterly dividend has never been reduced (and usually increased) since the company’s spinoff in 2004.
• The company is well capitalized and has sufficient cash flow to maintain the dividend and continue to grow the business.
• Finding news about the company outside of it’s website is almost impossible.

The company I am discussing is Ship Finance International Ltd. (SFL: 12.27 0.00 0.00%). Ship Finance was spun off by Frontline (FRO: 5.20 0.00 0.00%) starting in 2004 as a leasing company with 47 of what had been Frontline’s tankers. The fleet now consists of 59 vessels (33 tankers) of various types with another 14 on order. The fleet currently has an asset value of approximately $7 billion vs. a little over $2 billion in long term debt.

SFL’s business model has them lease their vessels on long term (10-20 years) bareboat leases. They get paid first on the money the ship’s lesees earn plus have profit sharing above a certain income level on many of the ships, notably those leased to Frontline. The dividend payout is between 30% and 40% of free cash flow, leaving plenty of cash left to continue growing their fleet.

Ship Finance stock is a buy anytime the share price is pushed down enough to drive the yield over 8%. Combine SFL with my other Income Portfolio tanker company, Nordic American Tankers (NAT: 14.59 0.00 0.00%) to get a pair of well run shipping companies that allow you to profit from the tremendous swings of this sector. Reinvest your dividends into which ever of the pair is the best value at the time.

Note: I have long positions in SFL and NAT

Renewable Fuels Association poll results

The Renewable Fuels Association contracted a pair of polling firms to survey voters beliefs on ethanol as a renewable fuel. Two firms were selected to get both Democratic and Republican opinion. The opening paragraph of the report, linked above, gives the results:

The on-going campaign to force the nation to revisit and reduce its commitment to ethanol has failed to move most American voters. A recent bi-partisan survey of 1,200 registered voters shows that by a 2:1 margin, the public supports increased use of ethanol in our nation’s fuel supply. This majority crosses party lines, capturing conservatives and environmentalists alike. Voters largely blame the rising cost of food on fuel prices; less than one in ten blame the expanded use of ethanol.

59% of votors support increased use of ethanol while 30% oppose. The survey oversampled environmentalists and in that group 63% supported increasing ethanol production. Also, voters polled believe higher oil prices are causing increased food prices by a margin of 71% to 17%.

It appears the anti-ethanol campaign has failed to sway the American voting public, so I doubt elected officials will be changing the current laws regarding ethanol. My contention that ethanol is a growing integral part of the U.S. motor fuel infrastructure continues to strengthen. Those that think corn based ethanol will soon be history are in the wrong (and smaller) camp.

As this is an investment oriented site, take a look at VeraSun Energy (VSE: 0.00 N/A N/A) when they release their quarterly earnings early in August. You may be surprised.

Note: I have a long position in VSE.

I have been thinking about this topic for a couple of days, and the market results so far today (11:00 AM) seem to be giving an answer, so I better start with the question. The stocks I invest in and follow are of the smaller cap variety with little or no news between the quarterly earnings reports. Most of these have been hit hard by the recent market down turn, even though I believe their earnings and/or growth vectors remain intact. The question is: How will the stock prices react if the trends and projections from earlier times (last quarter!) are intact? Will stocks that have fallen 30%, 40%, 50% regain that ground, or does the market think we are in a new world, where even well run financial companies are only worth 3 to 4 times earnings?

The next 3 to 4 weeks will answer the question for the stocks I follow and I will report back the results. I have been waiting patiently over the last few weeks for this time to arrive and to find out if my research and belief in the direction of these companies is justified.

One more note: I take pleasure in reading the comments of the “end of the world” crowd that populate any article about financial companies or housing, primarily on MarketWatch.com. Today, Wells Fargo (WFC: 30.20 0.00 0.00%) comes out with a positive report that lifts the market and this crew is convinced the company cooked the books.