Inside Bank Jobs

 | Jun 19, 2012 | 4:30 PM EDT
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When I talk about the trade of the decade in small banks, I get questions from readers about how to play the sector and which stocks to buy. I try to be generous with individual stock names on Real Money but many are just too small to write about here. However, if the stock is of reasonable size and trading volume, I do try to name names.

The other question I frequently hear is about other ways to invest in the sector. There is an ETF sponsored by First Trust NASDAQ ABA Community Bank (QABA) and several small banks focused mutual funds. If you have access in your 401k or other retirement plan to the FBR Small Cap Financial Investor (FBRSX) or the John Hancock Regional Bank Fund FRBAX they are worth an allocation.  Both are proven funds with experienced managers who I would consider. Hancock also has a closed-end fund, The John Hancock Bank and Thrift Opportunity Fund (BTO) that trades right around its average 11% discount to net asset value that mire passive investors might consider for exposure to the sector.

As important as it to know what to buy, it is also important to know which stocks to avoid. In spite of the carnage in the sector, and the serious headwinds faced by small banks right now, not all of these stocks are cheap. Many of them are not safe. Unless you are speculating in private equity funded long shots with a small portion of your portfolio, you need to focus your efforts on safe as well as cheap. Avoid banks with low and declining capital rations, high Texas ratios or high loan-loss ratios. Do not pay a big premium top tangible book value for bank stocks right now. There is just no long-term reward in doing so.

When looking for stocks to buy, I seek out high levels of insider ownership and insider buying. For stocks to avoid insider selling is a tremendous indication that your funds are best deployed elsewhere. Even in this horrific environment for bank stocks, I found a few names this morning where insiders are selling and the stocks are best avoided. We have a huge pool of bank stocks from which to choose, so if the folks running the place are selling, I will suggest that we do not want to buy their shares.

One bank that is seeing heavy selling is Bank of the Ozarks (OZRK). This is a very well-run bank with one of the highest returns on equity in the industry. It has recovered nicely from the depths of the crisis and earnings have grown at about 25% annually for the first five years. If you bought shares in that brief shining moment in 2008 when they traded below book value you have quadrupled your money. The bank is a classic example of buying quality merchandise at the point of maximum pessimism as the easiest way to make money in the stock market. The stock now trades at 2.3x tangible book value and is too expensive for long-term investors. Insiders would appear to agree, as they have sold roughly 750,000 shares in the past six months.

Texas Capital Bancshares (TCBI) is another stock that is a victim of its own success. The bank focuses on the business-friendly and economically sound Lone Star State. This single-state focus has been very successful.  Throughout the banking crisis, it has had small loan losses and one of the highest returns on equity and assets in the industry. At the depth of the crisis in 2009, you could have bought the stock at a substantial discount to tangible book value. But the stock's price has since risen more than sixfold and currently trades at 2.3x book value. Insiders are not as bullish on the stock as they once were. Officers and directors have sold more than 170,000 shares of the bank in the past six months.

These are well-run banks that weathered the storm with a great deal of success. If you bought their shares at the depths of the crisis, you have done extraordinarily well. However, the shares are no longer cheap and insiders are taking profits. You will have to wait for the next point of maximum pessimism to get involved with these two bank stocks.

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