Instead of Running Around Like a Crazed Chicken

 | Oct 25, 2012 | 4:30 PM EDT
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I've continued spending a lot of time thinking about the small bank trade this week amid still-strong improvements in balance sheets and bottom lines in the space. What we are not seeing is a truly strong rise in the valuation -- these stocks are still fixed at roughly 80% of tangible book value, on average, and in my view this creates an enormous opportunity in regional and community banks. I have been trolling around the Internet the past few days, looking for articles and commentary on the group that either reinforce or deflate my opinion thereof. It has been an interesting experience.

This morning I ran across the most recent commentary from the managers of the John Hancock Regional Bank Fund (FRBCX). Back in the 1990s, this was my favorite mutual fund for small investors who wanted to participate in the opportunities created by the savings-and-loan crisis. The fund has struggled with the collapse of the sector for the past decade, but it now improving dramatically as banks have been restored to profitability and viability in the past year. I am not much of a mutual fund guy these days, but if I had access to this fund in my 401k program, I would not hesitate to put some money in regional banks via a fund.

The fund manager's commentary runs pretty much in line with my thinking -- that regional and community banks are undervalued on both an asset and earnings power basis. Credit costs are declining rapidly, and that should lead to fairly strong earnings growth over the next few years. The banks are building capital and growing book value, and the stock prices are not improving at the same pace. As nice as the commentary is to read, the fund also publishes a list of holdings every month. By doing a little comparison work, we can see what the fund has been buying of late, and this is valuable information.

One of the fund's largest buys in September was East West Bancorp (EWBC). Investors were concerned that earnings growth was slowing at the West Coast institution, and the shares pulled back a bit, but those fears appear to be overdone: The bank just reported a solid quarter, with earnings up 17%. East West has a unique niche, with its focus on the Chinese-American community and on other Southeast Asian immigrants. In addition to its offices in the U.S., the bank has branches and representative offices in China. Nonperforming loans are just 1.04% of total loans, and reserves are almost twice the total bad loan exposure. At 1.5x tangible book value and 11x earnings, the shares are not "Tim" cheap, but they are worth considering if the shares sell off closer to tangible book or a to single-digit earnings multiple.

John Hancock Regional also increased its position in BSCB Bancorp (BLMT), a Massachusetts holding company for a five-branch savings bank that underwent a mutual-to-stock conversion just about a year ago. This is a classic cheap bank stock following the conversion. The shares are trading at 88% of tangible book value and have a tangible-equity-to-asset ratio of 17x. Loan losses are at just 0.44% of assets, and the loan-loss reserves stand at more than 160% of nonperforming assets. The company is seeing strong growth in core deposits, and management has indicated that loan demand is starting to pick up in its service segment. Insiders like the value and direction of the bank -- they've been steady buyers of the stock since the conversion a year ago. This stock is a buy at current levels and I would look to scale into more should the shares drop in a market-related selloff.

Bank stocks are dominating the market-related conversation around Chez Melvin these days. I know that I am supposed to be running around like a crazed chicken over earnings season, but I prefer watching the World Series and reading reports from banks and bank-investment funds. I suspect that my path will not only be more relaxing but far more profitable.

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