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Friday, November 09, 2012

Bank On It

As everyone is focusing on quarterly earnings reports, political comments and Central bank spokespersons from around the globe, I am doing my best to enjoy some relative serenity away from the fray. The mad rush of earnings reports and resulting trading frenzy has always struck me as ridiculous herd like behavior and I want no part of it. Instead I have kept my focus on researching solid undervalued opportunities in the hopes that the misguided short term activities of other will create opportunities for long term value types like me.

In the aftermath of the Annapolis National Bank (ANNB) deal announced earlier this week my attention is really narrowing into small banks. I have talked often about what I call the trade of the decade and Annapolis National is typical of what I think will happen. FNB Corp (FNB) made an all-stock offer for the bank of a little more than $12 a share. That’s about 240% above where I recommended Annapolis national back in April and about 160% of tangible book value. Smaller banks are going to be acquired at a pretty good pace over the next few years and there is an enormous amount of money to be made.

I have my own screening and search tools for small banks but sometimes I take a more casual approach and surf around the web looking for interesting articles and comments on community banks. I am glad I did because I stumbled across a recent presentation from PL Capital, the mangers of the Financial Edge hedge fund, that makes a strong case for the banks and contains information that can help us all make money. The firm invests in smaller banks and is not afraid to take an activist approach.

They point out that there are more than 700 banks in the United States with less than $10 billion in assets. Compliance and regulatory costs are going higher and these impacts small banks far more than the large banks. It will make sense for smaller institutions to be acquired by larger concerns to reduce the expenses as a percentage of income. The firm points out that the banking sector is healthier than the general perception. Over 80% of banks are profitable now. Loan losses have improved dramatically form the depths of the crisis. The banking industry still has plenty of room to grow according to the presentation. US Bank assets are a percentage of GDP are one of the lowest in the developed world.

Bank stocks have been hit hard over the past five years and are deeply undervalued. The NASDAQ Bank Index is down almost 50% since the end of 2006. The SNL Thrift Index is down more than 70% over the same time period. The last two times bank stocks sold off to these levels investors made enormous profits. Following the RTC crisis of the late 80s and early 90s the NASDAQ Bank Index rose by more than tenfold in less than a decade. In the aftermath of  the Long term capital debacle bank stocks rose by more than 300% in a little over five years. Banks have now been hit by the financial Crisis and a follow up blow from the European bank issues and offer substantial recovery potential over the next five to ten years.

Unlike most of these presentationsI see PL capital actually gives a stock pick as an example if their activist positions. HFC Financial (HFFC) is a $1.2 billion in assets bank where the firm has fought for and won a board seat. The shares trade at about 90% of tangible book value and have less than 25 in non-performing assets. The tangible equity to asset ratio is a little lower than I like to see at 7.78% but I think this is offset to some degree by the high quality loan portfolio.  The bank operates in one of my favorite regions, the upper Midwest with location in Minnesota and South Dakota. Pl Capital is not the only activist in the shares as Jacobs Asset management recently disclosed a 9.8% stake in the bank. This is a solid bank trading below book value that should return substantial value for long term investors.

Most of PL Capitals positions are too small to write about on Real Money with market caps well under $50 million. It is instructive for investors to dig through their SEC filings in search of the stocks they have been buying. There are some gems on the list worth buying.This was a great discovery from my bank based web searching. I am going to troll the net some more to see what else I can uncover that might lead to profitable Trade of the Decade ideas.

This morning I ran across the most recent commentary form the managers of the John Hancock Regional Bank Fund (FRBCX). Back in the 1990s this was my favorite mutual fund for small investors who wanted to participate in the opportunities created by the savings and loan crisis. The fund has struggled with the collapse of the sector for the past decade but is improving dramatically as banks are restored to profitability and viability in the past year. I am not much of a mutual fund guy these days but if I had access to this fund in my 401k program I would not hesitate to put some money in regional banks via a fund.

The fund manager’s commentary runs pretty much in line with my thinking. Regional and community banks are undervalued on both an asset and earnings power basis. Credit costs are declining rapidly and that should lead to fairly strong earnings growth over the next few years. The banks are building capital and growing book value and the stock prices are not improving at the same pace. As nice as the commentary is to read the fund also publishes a list of holdings every month. By doing a little comparison work we can see what the fund has been buying of late and that is valuable information.

One of the fund’s largest buys in September was East West Bancorp (EWBC). Investors were concerned that earnings growth was slowing at the West Coast institution and the shares pulled back a bit. Those fears appear to be overdone as the bank just reported a solid quarter with earnings up 17%. East West has a unique niche as it focuses on the Chinese American community and other Southeast Asian immigrants. In addition to its offices in the United States the bank has branches and representative offices in China. Non-Performing loans are just 1.04% of total loans and reserves are almost twice the total bad loan exposure. At 1.5 times tangible book  and 11 times earnings the shares are not “Tim” cheap but they are worth considering if the shares sell off to nearer tangible book or a single digit earnings multiple.

They also increased their position in BSCB Bancorp (BLMT) a Massachusetts holding company for a five branch savings bank that underwent a mutual to stock conversion just about a year ago. This is a classic cheap bank stock after the conversion. The shares are trading at 88% of tangible book value and have a tangible equity to asset ratio of 17. Loan losses are just .44% of assets and the loan loss reserves are more than 160% of nonperforming assets. The company is seeing strong growth in core deposits and management indicated that loan demand is starting to pick up in its service area. Insiders like the value and direction of the bank as they have been steady buyer s of the stock since the conversion a year ago. This stock is a buy at current levels and I would look to scale into more should the shares drop in a market related sell off.
Bank stocks are dominating the market related conversation around Chez Melvin these days. I know that I am supposed to be running around like a crazed chicken over earnings season but I  prefer watching the World Series and reading reports from banks and bank investment funds. I suspect that my path will not only be more relaxing but far more profitable.

originally published as a series of articles on

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