I will hop in my little truck on Sunday and head to Atlanta for the FIG Partners Bank CEO Forum. It is about a six-hour drive, which is right on the edge of my drive-or-fly line, but it is pretty much a straight shot so I will drive up.
This is one of my favorite conferences every year and although I am not looking forward to wearing a suit two days in a row, I do look forward to spending time with fellow bank stock investors and bank executives. Last year I got a chance to meet some folks who helped me fully understand what is going on in all phases of the banking world, and I look for a repeat of the experience next week.
One of the conversations I had last year and that has been repeated on numerous occasions since is whether to value bank stocks on an earnings multiple or just price to book value. I am an advocate of the price to book metric but some very smart folks who have done very well as bank investors think the earnings multiple should be considered as well as the asset measure. One of my goals for 2016 has been to be more open-minded about valuation techniques, so I sat down last night and ran some PE-based screens for small banks to see if I could find any ideas I may have overlooked.
Northrim BanCorp (NRIM) makes the list of banks that are cheap based on earnings. I don't think you can say I have overlooked Northrim, as I have mentioned several times that I spoke with them at last year's Atlanta gathering and came away impressed with management. The bank has 14 branches in Alaska with about $1.5 billion in total assets, and it has been growing at a nice pace the past few years.
Earnings have grown at about 12% annually while book value has been increasing by 7.2% a year. The bank is in great financial shape with an equity to assets ratio over 12 and nonperforming assets that are just 0.81% of total assets. The stock is trading with a PE ratio of 10 and is priced at 1.1x tangible book value right now, so while it has not fallen to my traditional buy levels, it is cheap on both asset and earnings measures. The stock also yields 3.1%, and the payout has been increasing by 11% a year for the past five years.
With the stock trading at 1.4x book value Clinton, N.J.-based Unity Bancorp (UNTY) would not usually hit my radar screen. However, on an earnings basis, the stock is cheap with a PE ratio of just 8.8. The bank is focused on business banking and about 50% of the loan portfolio is in commercial real estate. Nonperforming assets are just 0.76% of total assets, so the loan portfolio is in sound condition. The equity to asset ratio is a little low for my taste at 7.5%, but it has operated at this level for several years. The return on assets and returns on equity are above the industry averages, so Unity's approach seems to be working very well for them. I ran the cost-save valuation technique favored by PL Capital, and Unity has a takeover value that is about 70% higher than the current stock price, so in spite of an elevated price to book ratio on an earnings and takeover basis, the stock is cheap at this price.
Timberland Bancorp (TSBK) has been on my trade of the decade portfolio for some time. The stock is trading at a price to book ratio of 1.2, so it is more of a hold than a buy under my approach, but at 10x earnings it is still very cheap based on earnings. The bank is in decent financial shape with an equity to asset ratio of over 10 and nonperforming assets that are just 1% of total assets. I also ran the cost-save takeover valuation for this bank, and the rough takeover value of the bank would be more than 50% higher than the current quote. Timberland also has above-average returns on assets and equity, so it would deserve a premium multiple of book, and based on similar transactions involving high-earning banks the takeout value on price to book would also be significantly higher than the current quotation.
The search for low-PE banks produces a list community banks that might be worth owning by investors looking to take advantage of the trade of the decade.