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  1. Home
  2. / Investing
  3. / Financial Services

These 3 Small and Cheap Banks Are in a Perfect Storm Scenario

Small banks have powerful tailwinds that should lead to huge gains.
By TIM MELVIN Jun 26, 2015 | 01:00 PM EDT
Stocks quotes in this article: NBN, ASRV, FUNC

Once yesterday's column ran, I got a few emails and calls, all with the same question. What banks made the list of small and profitable companies? I left them out yesterday just to demonstrate that the small profitable company portfolios excess returns were not entirely small bank-driven. If anything, between 2007- 2010 small banks hurt more than they helped the overall portfolio. Since then they have performed a little better than the overall portfolio, but on balance over the last 15 years the returns have been in line with non-bank small profitable cheap stocks.

Having said that, it is no secret that I am a huge fan of small banks and it's the highest allocation in my current portfolio. The simple fact is that small bank stocks are in a perfect storm scenario, where the smallest banks need to sell because the continually rising regulatory and technology costs are making it almost impossible for them to remain independent, and the regional banks need to engage in buy-side M&A to grow earnings in a slow growth economy. Add in slowly improving real estate conditions in both commercial and residential markets, and the prospect for higher rates to improve net interest margins, and small banks have some powerful tailwinds that should lead to huge gains in the years ahead.

The largest bank on our list of small profitable banks is a familiar name. Northeast Bancorp (NBN) has popped up on just about every screen we have run in the banking sector of late. This is just a well-run little bank in the booming metropolis of Lewiston, Maine, with a clean loan portfolio and strong balance sheet. The stock is trading at 86% of book value and is profitable. In the most recent quarter, profits jumped up to $0.18 a share compared to just $0.04in the year ago period.

CEO Richard Wayne also thinks his bank's shares are cheap. "With regard to capital, we continue to believe that our shares are undervalued, based on current market prices. Our goal in implementing the amendment to the existing stock repurchase program is to continue to enhance shareholder value," he said in the press release. He has backed that conviction up with his own money; both he and the bank's chief operating officer have been buying the shares in the past few months. I am in full agreement with him, and think the stock is a great buy for long-term, value-oriented investors.

AmeriServ Financial (ASRV), based in Johnstown, Pennsylvania, is another small, profitable cheap bank stock worth buying. Nonperforming assets are just 0.25% of total assets, which is well below the national average of 1.03% for similar banks. The stock is trading at just 75% of book value, and earnings were up 40% year over year in the first quarter. AmeriServ management attributes much of the growth to the "successful results of the Company's sales calling efforts, with an emphasis on generating commercial loans and owner occupied commercial real estate loans particularly through its loan production offices."

The bank has a good mix of residential, commercial and multi-family loans in the portfolio, and has demonstrated by the low non-performing assets ratio that it does an above-average job of underwriting its loan portfolio. Long-term investors should be very pleased with the results they get from owning shares in this bank. The people running the bank certainly think so, as they have been enthusiastic buyers of the shares all year.

First United Corporation (FUNC) is a small bank in the mountains of Western Maryland that makes the list of profitable cheap banks. With the exception of the heart of the credit crisis years of 2008-2009, the bank has been consistently profitable for the past 15 years and the stock is cheap at 76% of book value.  The bank should benefit from the many tailwinds in the banking industry. A takeover of this bank would not be a shock at some point in the future either.

There are 23 other small profitable banks trading below book value on my list, but most of them are too thinly traded to talk about here. It would be worth your time to search for and research the smaller companies, both banks and non-banks, which form the small profitable company cheap stock list. The performance of these stocks has been very strong, and I expect it to continue to be strong in the years ahead.

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At the time of publication, Tim Melvin had long positions in NBN, ASRV.

TAGS: Investing | U.S. Equity | Financial Services

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