While everyone is focusing on quarterly earnings reports, political comments and central-bank spokespersons from around the globe, I am doing my best to enjoy some relative serenity away from the fray. The mad rush of earnings reports and the resulting trading frenzy have always struck me as ridiculous, herd-like behavior, and I want no part of it. Instead, I have kept my focus on researching solid, undervalued opportunities in the hopes that the misguided short-term activities of others will create opportunities for long-term value types like me.
In the aftermath of the Annapolis National Bank (ANNB) deal announced earlier this week, my attention is really narrowing into small banks. I have talked often about what I call the "trade of the decade," and Annapolis National is typical of what I think will happen. FNB Corp. (FNB) made an all-stock offer for the bank of a little more than $12 a share. That's about 240% above where I recommended Annapolis National back in April, and about 160% of tangible book value. Smaller banks are going to be acquired at a pretty good pace over the next few years, and there is an enormous amount of money to be made.
I have my own screening and search tools for small banks, but sometimes I take a more casual approach and surf around the web, looking for interesting articles and comments on community banks. I am glad I did, because I stumbled across a recent presentation from PL Capital, the manager of the Financial Edge hedge fund, which makes a strong case for the banks and contains information that can help us all make money. The firm invests in smaller banks and is not afraid to take an activist approach.
PL points out that more than 700 banks in the U.S. have less than $10 billion in assets. Compliance and regulatory costs are going higher, and this affects small banks far more than the large banks. It will make sense for smaller institutions to be acquired by larger concerns to reduce the expenses as a percentage of income.
PL says that the banking sector is healthier than the general perception. More than 80% of banks are profitable now. Loan losses have improved dramatically from the depths of the crisis. The banking industry still has plenty of room to grow, according to the presentation. U.S. bank assets as a percentage of GDP are among the lowest in the developed world.
Bank stocks have been hit hard over the past five years and are deeply undervalued. The Nasdaq Bank Index is down almost 50% since the end of 2006. The SNL Thrift Index is down more than 70% over the same time period. The last two times bank stocks sold off to these levels, investors made enormous profits. After the Resolution Trust Corp. crisis of the late 1980s and early '90s, the Nasdaq Bank Index rose by more than tenfold in less than a decade. In the aftermath of the Long Term Capital Management debacle of the late 1990s, bank stocks rose by more than 300% in a little over five years. Banks have now been hit by the financial crisis and a follow-up blow from the European bank issues and offer substantial recovery potential over the next five to 10 years.
PL Capital actually gives a stock pick as an example of its activist positions. HFC Financial (HFFC) is a $1.2 billion asset bank in which PL has fought for and won a board seat. The shares trade at about 90% of tangible book value, and the bank has less than 2% in non-performing assets. The tangible-equity-to-asset ratio is a little lower than I like to see at 7.78%, but I think this is offset to some degree by the high-quality loan portfolio. The bank operates in one of my favorite regions, the upper Midwest, with locations in Minnesota and South Dakota.
PL Capital is not the only activist in the shares, as Jacobs Asset management recently disclosed a 9.8% stake in the bank. This is a solid bank trading below book value that should return substantial value for long term investors.
Most of PL Capital's positions are too small to write about on Real Money, since they have market caps well under $50 million. It is instructive for investors to dig through their SEC filings in search of the stocks that PL has been buying. There are some gems on the list.
This was a great discovery from my bank-based web searching. I am going to troll the net some more to see what else I can uncover that might lead to profitable "trade of the decade" ideas.