Looking at Less Than Perfect Bank Stocks

 | May 30, 2013 | 3:00 PM EDT  | Comments
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Stock quotes in this article:

hfbc

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ucfc

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cbnj

I want to stay with our bank focus today and look at some banks that might fall outside the definition of perfect bank.

They may have loan losses that are a little -- or even a lot -- higher than the perfect little bank standard, but conditions are improving. They may need to raise some capital to get the equity-to-asset ratio up toward my preferred levels. They have more scars and bruises than perfect little banks, but there is still tremendous upside.

Most importantly, they have attracted the attention of an outside investor or private equity firm with a record of successful bank stock investing. These investors often are activists who intend to take an aggressive stance toward unlocking shareholder value.

A perfect example of this type of stock is HopFed Bancorp (HFBC) of Hopkinsville, Ky. The bank does business in Kentucky and Tennessee with 18 branches and $978 million in assets. The bank has come under fire from noted activist Joseph Stillwell. He contended that management had no business going forward with an acquisition of another bank when they have delivered so little returns with the assets already under their control.

Stillwell has advocated for a sale of HopFed to another institution to unlock the value of the shares. He has a point. The stock trades at just 80% of tangible book value and has adequate capital. Nonperforming loans are just 1.30% but returns on assets and equity are well below their peers. Stilwell won the first round of the fight by having his nominee elected to the board a few weeks ago. I would not be surprised to see the pending purchase of a neighboring institution cancelled and HopFed put up for sale in the near future. PL Capital and Arbiter Partners are also shareholders in the bank so there are a lot of smart eyes on the bank which could help force a sale.

United Community Financial Corp (UCFC) is another bank starting to attract attention form noted bank stock investors. The Youngstown, Ohio-based bank has 33 offices and $1.8 billion of assets. The bank has struggled with asset quality as nonperforming loans are still a little north of 4% -- well above the national average in a recovering market. They have been making substantial improvements. In the first quarter of 2010 total nonperforming assets were above 8% of total assets.

Today, they are down to 3.32% of total assets. The stock trades at 80 % of tangible book value so there problems would appear to be discounted in the current quote. The equity-to-assets ratio is 10 so they appear to have enough capital on hand to navigate through the troubled waters. At least two noted bank investors think so as EJF Capital has been a buyer of the stock and our old friends at FJ Capital just filed a 13G disclosing ownership of more than 5% of the bank.

The bank raised additional equity earlier this year in a private placement and conditions are improving slowly. As the economy recovers and the Youngstown market begins a long slow recovery, this bank should see their problems disappear and profits to begin growing once again.

Cape Bancorp (CBNJ) is another bank that has been showing up in the portfolio of seasoned bank stock investors. Michael Price, PL Capital and EFJ Capital are all owners of the 15-branch, $1 billion in assets institution. The bank serves the Cape May and Atlantic County areas of New Jersey including the beach towns of Wildwood and Atlantic City. Nonperforming loans are declining from almost 6% a few years ago to just 2.57% right now.

The bank is still chipping away at its other real estate-owned portfolio with the total decreasing by $1 million last quarter. As the economy improves the bank should see strong profit growth and could be a takeover target given its attractive service area. The shares are trading right at tangible book value and they have plenty of excess capital which they are using to buy back stock.

The trade of the decade is developing and is reaching the sweet spot. By the end of the year we should see merger and acquisition activity begin to pick up. I think this sector is going to soar by multiple five to ten times the current quotations over the next decade. The train is building steam and it's time to board.

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