Small Can Be Good With Banks

 | May 29, 2013 | 12:00 PM EDT
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Over the past two years the Trade of the Decade in bank stocks has taken shape nicely. I have suggested and purchased dozens of little banks, and even a few larger ones, and they have done pretty well so far.

We have had a few takeovers along the way already but nothing like we will see over the next three to five years. Credit conditions have slowly, but surely, improved and banks have reorganized or disposed of many problem assets during this period. This morning, Moody's upgraded the industry from a negative outlook to stable as a result of improving conditions. In spite of the improvement there are still plenty of bank stocks to buy as Wall Street continues to focus on the earnings outlook for small banks and not the asset value and potential for merger and acquisition activity.

The first group of banks that make up a Trade of the Decade portfolio is the smaller banks that are just sleepy little firms that no one really notices. They have solid loan portfolios, an adequate or even excess amount of capital and the shares still trade below tangible book value. They are not making headlines and they won't be the subject to cocktail party chatter unless you happen to live in their hometown and have an account with them. Until the day they get taken over they probably won't be the short-term performance leader. But my experience has been that if bought right, these stocks will almost always be among your top long-term performers.

One such bank is ESSA Bancorp (ESSA) a 26-branch bank located in Stroudsburg, Pa. I have owned this stock for some time and it really has not done a whole lot. They bought First Star Bank last year to increase their presence in the Lehigh Valley and the purchase is working out well for them. The stock trades at 83% of tangible book value and the equity-to-assets ratio is a little over 11. The balance sheet is in good shape with nonperforming assets at just about 2% of total assets.

The Berkshire Bancorp (BERK) is another bank that has been on my list of bank stock buys for what seems like forever. This is a 14- branch banking institution with $793 million in assets located in New York City. The stock trades for less than 90% of tangible book value and the bank has plenty of capital with equity-to- asset ratio of more than 16. The loan book is rock solid with nonperforming loans at just .39% of total loans. It is not a particularly exciting stock, but is a well-run, profitable financial institution that is both safe and cheap at the current price. Berkshire closed Tuesday at $7.79 and was trading just above $8.00 in late Wednesday morning activity.

Taylor Capital Group (TAYC), the parent of Chicago-based commercial bank Cole Taylor bank, could easily be the poster child for the improvements we have seen in the banking industry. The bank serves closely-held business firms and the people who own them, and also engages in asset-based lending, commercial equipment leasing and residential mortgages. The bank has steadily worked down the problem loans and real estate. As the economy improved, total nonperforming loans have fallen from more than 5% to less than 2% at the end of March. In spite of improving conditions the stock still trades for just 80% of tangible book value at the current price.

The San Joaquin Valley of California was ground zero for the real estate collapse but at least one bank in the region has managed to stay in good shape throughout a difficult time in the region. The Fresno based bank, Central Valley Community Bancorp (CVCY), is a 33-year old bank with 17 branches and $885 million in assets. They just received approval to buy Visalia Bank which will give them 21 branches and more than $1 billion in assets when the transaction closes. The bank has nonperforming loans of just 1.24% of total loans and the equity-to asset-ratio is a very healthy 13. The stock currently trades at just 90% of tangible book value. As California and the Central Valley recover, this stock should do extremely well for long term investors. Patriot Financial Partners, a bank focused private equity group owns 11% of the shares and one suspects they are looking for a long-term payoff of many times the current stock price.

The core of a Trade of the Decade portfolio is made up of what are pretty boring little stocks. They will move like bunny rabbits over time, trading in a tight range before leaping ahead on good news or possible takeover offers. Patience pays with these stocks but the small bank stocks have the potential to be the best investment of your lifetime.

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