Community banks are not entirely immune to the rising tide effect. In recent months, I have noted that many of the small banks have drifted up towards book value. While they are still undervalued on a historical basis, I am kind of a fanatic about buying them below book value.
In the past few years I was always able to find plenty of little banks between $100 and $200 million in market cap to write about and buy. That is not really the case today. Last week, I added three banks to my portfolio, and the average market cap was a whopping $34 million. While on average they traded about 5,000 shares a day, the smallest traded just 796 shares a day on average. That's a little too small to write about on a widely followed forum like RealMoney.
When I sit down to select banks, I look for three factors. Over the years I have found that stocks trading below book value, with non-performing assets under 3% and with equity-to-asset ratios over 10 have been the most consistent performers. I do pick some special situations that may fall outside that box, but those three are my go-to factors. While things like return on equity and assets as well as efficiency ratio do matter, if you get the first three right, a ROE that is too low or an efficiency ratio that is too high may actually be positive.
A bank with a sound balance sheet and loan portfolio that is underperforming on management factors is probably going to attract the attention of an activist or asset-hungry competitor. Once I find banks that fit the big three criteria, I then check the shareholder list in search of smart and activist money as co-investors
There are a few banks that are just large enough to fit my model that we can talk about. Northeast Community Bank (NECB) is based in White Plains, New York and has nine branches with just over $500 million in assets. It certainly has plenty of capital, with an equity to assets ratio of over 17. Non-performing assets are a little on the high side of the ledger, at 2.6%, but the high capital levels make this less of a concern. The price is right, as the stock trades for just 84% of book value at the current price.
The biggest shareholder is Joseph Stilwell, a bank stock activist with a very high success rate at forcing the sale of a target, or finding other ways to increase shareholder value. The second-largest shareholder is Funds LLC, a community bank specialist with a strong track record. Northeast Community has a dividend yield of 1.67%, and management has been buying back stock. The loan portfolio is heavily into commercial real estate, and almost 60% is in the New York City suburban multi-family homes market, which has been one of the best real estate markets in the U.S. the past few years.
Northeast Bancorp (NBN) may share part of the name, but it is a very different bank than Northeast Community. It has 12 offices and a little over $800 million in assets, located in Lewiston, Maine. The bank has plenty of capital, with an equity to assets ratio of 12.6. The non-performing assets ratio is just 1.77%. The portfolio is skewed towards commercial real estate, but it has far fewer multi-family loans on the books, and residential real estate is still more than 20% of the total portfolio. The stock is cheap enough at 85% of book value, and I am encouraged to see that Michael Price and Franklin (BEN) are both large shareholders.
At 93% of book value, Philadelphia-based Prudential Bancorp (PBIP) is pushing the upper limits of my buy zone, but I think it's OK to step up on this bank, for several reasons. With an equity to assets ratio of over 17, it has plenty of capital, and non-performing assets are just 1.17% of total assets, so this bank stock is safe and cheap. The shareholder list if full of very smart money. Activist Lawrence Seidman is the largest shareholder, and another activist fund, PL Capital, also owns shares. Other smart money shareholders include Firefly Value, Michael Price and EJF Capital. I am willing to pay up a little to join their company.
The small bank stock Trade of the Decade train is leaving the station. All aboard that are coming aboard! If you hurry, you can still get a ticket to what should be one of the most profitable long-term investments of your lifetime.