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Sunday, August 18, 2013

Bank Stocks and Alligators

This weekend my daughter was in town and we took a trip down to the Keys though the Everglades. I have never driven the entire length of Highway 41, the Tamiami Trail, and was fascinated by the idea. Along the way we took the mandatory airboat ride back up into the glades and it was quite an experience. I confess to an admiration and fascination of alligators and although I see them all the time walking the dog here in Windermere, this was alligator heaven. They were everywhere and they were enormous. I do not know if you have spent any time watching gators but they are pretty opportunistic creatures. They do not hunt as much as wait for something to be foolish enough to get closer and then they pounce. They tend to eat a lot of smaller animals that wander by but will occasionally take down bigger prey like a deer that makes a crucial mistake. If nothing comes close they are content to float around the lake or take a nice nap in the sun.
Being small bank stock investor is a lot like being an alligator. It is an opportunistic approach as we tend to wait for banks to come to us in price and value and not force the issues. We are looking for the smaller banks most of the time but in environments like 2009 and 2010 larger regionals will also get cheap enough to buy. We wait for perfect little banks with strong loan portfolios and balance sheets to be cheap enough to buy at a large discount to book value or for an activist on other influential investor to take a stake in a special situation bank that has less than perfect loan portfolios or needs capital. If nothing comes by today that is cheap enough we are quite content to just hold what we have and wait. Days and even weeks can go by without a trade. I have owned banks for years that steadily appreciated but at a slower pace than the book value grew so they never became overpriced. I have gone months without adding a new name to the portfolio.  When prey is rich on the ground in periods like 2003 to 2005 and 2008 to 2010 I can become fully invested in an instant. It is a very opportunistic and patient approach to the markets. A good friend once described small regional and community investing on a value basis as the most productive and boring way he ever found to make money in the stock market.
Perusing the bank call reports for the second quarter shows a drop in total banking assets for the second quarter in a row. The biggest drops are in trading assets and real estate owned as banks continue to dispose of troubled assets and cut back on riskier activities. Net loans and leases increased slightly in the quarter with farm loans and car loans leading the way. 1-4 family mortgage and junior lien lending continues to decline as does home equity loans. Commercial and industrial loans as a percentage of total loans are at a very high level of 20.1%. Big banks are rushing to make these loans while ignoring mortgage loans to the greatest degree possible. This bears watching. So does smaller banks exposure to muni bonds in the aftermath of the Detroit bankruptcy as they have long been a safe haven for smaller banks looking for safer investment securities.
Small banks really are the trade of the decade. These quiet little almost boring  stocks can make you a fortune. In the aftermath of the S&L crisis the bank stock indexes rose roughly 10 fold over the next decade and I see no reason the same won't happen this time as banks are ripe for consolidation at current levels.

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