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Tuesday, July 09, 2013

Cheapest Banks

It was bought to my attention that in last week’s articles on the cheapest stocks no banks were mentioned. I assure you this was intentional on my part. As part of my ongoing efforts to avoid anything remotely resembling frolicking here at the beach I have spent my time calling everyone I ever met to discuss weighty and lengthy business matters. I also set aside several matters that would require in-depth arduous research and consume as much of the daylight hours as possible. While the others are engaging in traditional beach activities I am on the deck considering bank stocks over a cup of coffee.

While the larger regional banks caught fire last week as investors realized that higher interest rates could actually be good for them this really did not trickle down to the smaller community banks. These stocks are not attracting much investor interest. They are too small for most institutional investors and individual investors. The have moved up off the lows but their valuations do not reflect the vast improvement in their balance sheet and financial condition. The returns from these stocks over the next five to 10 years will be breathtaking in my opinion

The bank stocks that rank among the very cheapest on a price to book value basis have some ongoing problems that have caused the very low valuations. Some are still dealing with credit and loan loss issues while others will need to raise capital. Others are simply struggling to remain profitable due to low net interest margins and higher regulatory and compliance costs.  As a result these banks have a few proverbial fleas on them. If they are able to dust off the fleas and clean up their act the stock prices should rise by several multiples of the current price.

I am a little constrained by market cap and liquidity issues as the very cheapest bank stocks are too small and illiquid to write about. However the cheapest of those large enough to mention is actually the largest bank on the list. I have discussed Synovous Financial (SNV) and will not reinvent the wheel here. Suffice it to say the bank is rapidly cleaning up its act and the stock is very cheap at just 60% of tangible book value. They sold off some distressed assets and but the bullet and charged off others to clean up the balance sheet. The stock may not get back to its pre-crisis highs in above $30 a share but even halfway back would be a 6 bagger.

Intervest Bancshares (IBCA) is hitting new highs but the stock still trades for less than 70% of tangible book value. I confess to missing the boat on this one as the stock did not fit my strictest guidelines and I missed the 13d filings by several sharp bank activists. The bank has cleaned up its act and is no longer operating under restrictions from the Office of the Comptroller of the Currency, although the holding company is still bound by an agreement with the Federal Reserve that restricts some activities. They were recently successful in buying back some TARP securities from the Fed. It may take some time for nonperforming assets to get back to the level of their peers but the upside is tremendous if they continue to have success.

Mutual First Financial (MFSF) is also on the list of cheapest bank stocks. This stock first came to my attention when the guys at PL Capital filed a 13d on the stock earlier this year. The activist firm owns 8% of the bank but has not put forth any activist proposals so far. The bank is not setting the world on fire but conditions are improving steadily. Nonperforming loans are 2.52% of all loans, roughly in line with its peer group. The equity to asset ratio is 10 so they have adequate capital right now. The ROE and ROA are well below their peer group right now but that should improve with time. If it doesn’t look for increased pressure to sell the bank.  A sale would be well above the current 70% of tangible book value.

Several of our old favorites are still on the list as well. Berkshire Bancorp (BERK) has not done much in the last year but it is still cheap at 80% of tangible book value. Pacific Mercantile  (PMBC) is still at less than 80% of tangible book value as well. The super cheap banks may take some time to see their price improve but for long term investors the greater risk is in not owning these trade of the decade stocks.

Cheapest Stocks

Today begins that annual adventure that my wife calls vacation. As near as I have been able to determined vacation is a process that involves me packing up my computer and research material and moving it to another location in a town with a beach. There is also a clause in our vacation policy that includes additional family and friends hanging around to irritate and interrupt me during the day. This year is New Smyrna Beach and at least I will have an ocean view while I am working.  Before I head off on this joyous occasion I spent some time today searching for the every cheapest stocks in today’s market.

Over the years I have found that is very important to own the very cheapest stocks that do not appear to be headed for liquidation or failure even if I am not that fond of the business. These very cheapest of stocks often end up providing a significant percentage of returns on an annual basis even when they don’t have a great theme or story to attract buyers. The act like bunny rabbit most of the time just hanging around at low prices until some event or news sends them hopping higher very quickly.

Penn Virginia (PVA) is a classic example of such a stock right now. I am really not a big fan of management at this company. They have missed several opportunities to maximize shareholder value, levered up the balance sheet and sold stock well under book value. The positive is that they won some own some assets with huge upside potential in the Eagle Ford basin and the stock is ridiculously cheap at less than 40% of tangible book value. They have been about to increase oil production and that should be 70% of the output next year. Hopefully they sell some assets during the next 12 months and use the cash to reduce debt levels. I would not have a huge position in the stock but I do have a small one. If things work out over the next few years the stock could easily triple or more.

I have owned National Western Life Insurance (NWLI) several times over my career and I own a little bit right now. The company writes a lot of interest sensitive business such as universal life insurance and retirement annuities. As you would expect this is not the best of businesses with yields at current levels. The share structure gives the Chairman control of the company so shareholders do not have much a say and I suspect this is the only reason this company has not been taken over before now. The company has done a solid job of managing the business in difficult times and at 40% of book value the weak business environment is not that big a factor. The stock is safe and cheap enough to buy.

Swift Energy (SFY) is not making the translation to oil and natural gas liquids as quickly as the marketplace might have hoped and the stock has been punished. They are continuing to transition for a shallow water driller in Texas and Louisiana to an unconventional oil and gas driller and although it may take longer than some expected I think it will be successful in the long run. I f I am right the shares will trade from the current level of 50% of tangible book value to a substantial premium to book. The early results from Eagle Ford are positive and the company should be able to increase its oil and liquids production over the next few years.

To my discredit I never pulled the trigger on shares of Genworth Financial (GNW) and the stock has almost tripled over the past year. Incredibly it is still cheap as it recovers from deep financial distress. The mortgage insurance business almost put these guys out of business but conditions are improving. They have placed several lines of business including variable annuities and Medicare supplements into run off. The long term care business is seeing strong results as the population ages and even the mortgage insurance business is showing signs of a recovery. In spite of the strong stock price performance the shares still fetch just 40% of tangible book value. I am not going to chase the stock just yet but if we get a broad market pullback I will be a buyer of Genworth.

There are not a lot of cheap stocks around right now but history tells me that I need to own the ones I can find.