Small Banks Set To Thrive

 | Apr 23, 2012 | 12:30 PM EDT  | Comments
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In the financial world, the advantage has typically gone to the big boys with the economies of scale and geographic diversification. Yet the scale continues to tip towards today's smaller regional and local banking institutions.

And thanks to a small yet significant provision that was included in the JOBS Act that was signed this month, there's a lot more for investors to like about today's small banking institutions.

The underlying theme of the JOBS Act is to promote small business growth by making it easier for those businesses to access capital. Included in the Act was a provision that raises the number of shareholders at which small banks must register with the Securities and Exchange Commission to 2,000. Prior to this provision, the number was 500 shareholders.

For a small bank the difference between registering vs. not registering is significant. In dollar terms, the difference is up to $200,000 in annual cost savings. If you think about a bank with $500 million in assets generating a ROA of 0.5%, an acceptable return in today's environment, that bank earns $2.5 million a year in profit. The costs savings are significant, for the really small community banks. Yet 500 shareholders is very small number and many small banks actually managed their business with a focus on keeping the shareholder base low. That's how significant registration costs are to the bottom line of these smaller banks. Tt was far more prudent to hinder growth by reducing keeping the shareholder count to below $500 as the savings benefits far outweighed the return on investment from that growth. 

With the threshold raised to 2,000, the future for small banks has just become significantly more promising. The banks now have a green light to raise more capital without being subject to the onerous costs from registration. And in the banking world today, more capital is the Holy Ggrail. That additional capital will allow banks to acquire other banks in order to spur growth. Overall lending still remains so anemic and bank valuations remain so historically low that growth by acquisition is a very compelling strategy. As acquisition activity picks up, so will the valuation of the available pool of small banks.

Small thrifts, typically those that are local in nature, are most likely going to be the names with fewer than 2,000 shareholders. Without being an executive, you have to be a shareholder to access any company's shareholder list in order to determine the actual count. But because many local thrifts are predominately owned by insiders and the local the depositors with the remainder owned by the public, odds are good that they will benefit from this legislation.

Naturally, the list of names is a collection of really small banks by industry standards. A name like People's Bank Shares (PEOP) with a market cap of $100 million is probably on the cut line with respect to the 2,000 limit. As is common with many of the smaller banks, they have simple, clean, and very healthy balance sheets. People's Bank shareholder equity stands at $115 million against $552 million in assets, or a leverage ratio of less than 5 to 1. Of that asset base, more than $100 million is in cash. The bank trades at 90% of tangible book and non-performing assets were 0.89% of total assets as of year end 2011.

Other intriguing names include Alliance Bancorp of Pennsylvania (ALLB), Standard Financial (STND) and Naugatuck Valley Financial (NVSL). These small local banks all have quality balance sheets and trade well below tangible book value. Many use the excess capital to pay dividends and buy back stock.

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