When I’m looking at the banking industry, I see something very different from your typical investor. It is not a homogeneous group that reacts in the same way to the economy. I follow around 700 uniquely different banking institutions. At some point of time, every bank in that sector provides value. My objective is to identify it.

Q: Could you explain your portfolio construction process?

A: I currently manage around $200 million in institutional money. All of it is devoted to banking and financial services companies 97% of portfolio allocations are in banking companies. Depending on the size of the account, there would be from 20 to 50 banking companies in an account.

At RASARA we have historically weighted our investment allocation. We like to invest about 70% in diversified and specialized banks and 30% in traditional banks. We have structured our portfolio in such a way that we are not impacted by interest rates as much as the broader market would expect for someone holding a bank portfolio.

We identify banks with investment themes that may positively impact their market value and banks with low P/Es and good fundamentals. We follow a value-oriented approach to investing. We start with about 700 stocks of our banking universe, then narrow it down to about 50 and subsequently to the best 40 or 20 names that we think provide the best price appreciation potential.

Q: Do you set a price criteria for your buy or sell discipline?

A: Yes. When we narrow the bank universe down to the best names, we apply proprietary valuation analysis to come up with upside targets. We may apply a buyout or a takeover scenario or a peer-group analysis to identify what bank looks cheap in a certain sub-sector. If the bank has a low P/E, we develop a reasonable scenario where it could attract a higher P/E and value it on that basis. For the most interesting candidates once I determine their intrinsic value, I try to buy them at a discount of 20% to 40%.

Once I establish a buy point I will sit and wait patiently. I wait for bad news. I also employ technical analysis to cut some of my downside risk when I finally take a new position in a company.

Q: How is your research process different? Do you combine quantitative and the fundamental research?

A: Yes. We typically weed out all the micro-cap community-based banks. That leaves us with a universe of about 100 names. We conduct research to determine which geographic sectors of the US banking industry hold particular investment promise And we look at the types of issues that might impact the companies. Since I've got 25 years of experience at this sector, I am not afraid to make my own prognosis in terms of looking beyond the horizon.

New York Community Bank (NYB: chart) is a good example of how I invest in a stock. The stock price is down about 45% from its 52-week high based on asset liability mismatches. The company has a dividend yield of about 5 percent. I am earning the 5% dividend yield while waiting for either a takeover catalyst or for earnings to rebound to its historical 10% to 15% range.

I also like to look for companies that have certain proprietary skills or a business niche. An example of this is United Commercial Bank (UCBH: chart). It is not a widely followed bank. On the surface it looks like a typical small-cap banking company, but it is unique in providing services to the ethnic Chinese community in San Francisco; and now it is trying to expand in the Washington area. It has been growing earnings from 17% to 20% per annum. I have made a lot of money in the stock over time.

Q: What are the risk-related issues you deal with?

A: RASARA builds portfolio diversification at multiple levels. In terms of revenue generation, we look at banks based on net interest revenue and non-interest revenue. A large portion of the banks we
invest in tend to be either diversified or specialized banks.

We also construct client portfolios with geographic focus on the business – locally, regionally, and nationally. You can take any particular state and I am considering whether or not there is any interesting investment prospect. On a regional basis, I might anticipate a pick up in merger and acquisition activity in a certain area. For example, in the past the southeast and the midwest were fairly active areas in terms of mergers and acquisitions.

Small and mid-cap banks make up roughly 80% of a client’s portfolio. Largecap banking companies account for about 20% of the portfolio. The large-cap bank holdings resulted from smaller banks we held being acquired by large-caps, and I elected to keep the acquirer until it reaches a certain price target.

There is also the issue of credit or asset quality risk. We look to mitigate this by investing in banks that have very conservative underwriting procedures. With our diversification process we are not putting all of our eggs with one or two banks or any particular region in the country.