In this market of higher highs, it gets more and more difficult to find pullbacks that are buying opportunities and not warning signs of more serious problems. For our next position in our Absolute Capital Return Portfolio, however, I want us to add one of those increasingly rare opportunities in a stock that pulled back last year, has stabilized in recent months, and has strong growth prospects to drive it higher.
New Position: Texas Capital Bancshares (TCBI)
Type: Mid-Cap Stock
Allocation: 8%
Strategy to Open: Buy up to $43.50
Texas Capital Bancshares (TCBI) is the parent company of Texas Capital Bank, a commercial bank with five full-service locations in Austin, Dallas, Fort Worth and San Antonio. The company’s plan is to continue to grow its commercial lending business by targeting middle-market companies and successful entrepreneurs, and by hiring additional established Texas bankers. This would build on rapid growth in its loan book in recent years, more than doubling from $4.5 billion at the end of 2008 (when the financial crisis was at its peak) to $9.9 billion at the end of last year. As you would expect, this has driven strong growth in earnings, which more than tripled over the same period from $0.87 a share to $3.00.
Here’s the other important part of the equation: This loan growth is being largely financed by an increase in deposits, which have also more than doubled from $3.3 billion in 2008 to $7.4 billion. Deposits should remain strong as the population in Texas increases, with the numbers of residents expected to grow from 25.3 million in 2010 to 30.8 million by the end of this decade.
Greater deposits enabled a relatively high net interest margin of 4.41% in 2012. That was lower than 2011’s 4.68%, but I look for a recovery to previous levels because the Federal Reserve is likely to keep short-term interest rates near 0% – even after quantitative easing ends. This would lead to higher long-term rates, and the greater spread between short-term and long-term rates (called a steeper yield curve) boosts net interest margins for banks like TCBI.
We always need to consider losses on loans when owning a bank, and TCBI passes muster here with good credit performance. Even at the peak of credit losses in 2010, the company still earned a then record $1.02 that year. Nonperforming assets as a percentage of total assets has been low historically for TCBI, and has in fact declined from 1.14% in 2008 to 0.71% in 2012.
TCBI trades at 12X 2013 estimated earnings of $3.71 a share, which is not cheap for a bank. The company does not pay a dividend, instead storing its capital for future growth, so that is where we focus. We know that growth will slow from the rapid pace of the past five years, but there are two important considerations. On a fundamental level, growth will be better than that of the average bank, and the company’s asset quality is strong thanks to its superior credit performance. From a valuation standpoint, the correction in the stock from its peak of $52 in early October has discounted the slower growth, perhaps overly so, which lessens future downside risk and sets the stage for the stock to do well from here.
Buy TCBI up to $43.50 and allocate 8% of your portfolio to the position. The stock has strong support just under $42, which is not far below current levels, and we’re buying at the low end of its recent range. I’ll be watching closely to see if the range holds, and my expectation is that it will start to move higher as investors look ahead to future growth.