Small, Struggling Banks Can Make Great Takeover Targets

 | Oct 05, 2016 | 2:30 PM EDT
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Today I want to take a look at some small banks struggling to grow and at the point where they need to pull a rabbit out of the hat or sell to a larger institution. We know from the studies at the Fed's Community Bank in the 21st Century Research and Policy Conference that the bigger banks are doing a better job of executing, and the economies of scale that exist in the community banking business favor the larger institutions.

As I mentioned yesterday, investing in community banks is somewhat counter-intuitive. We are not looking to buy star performers like Home Bancshares (HOMB) or Capital Bank Financial (CBF) that are growing assets and earnings -- and their shares are priced like it as well. We want those banks to buy one of our little banks so we can back into their stock at a big discount.

The banks we want to buy are struggling to handle the rising costs of technology and regulatory compliance. Here are three examples.

Anchor Bancorp (ANCB) , which has 10 branches in Washington state, should have already been sold. It's come under activist pressure in the past two years, with the latest campaign waged by Joseph Stilwell, one of my favorite activists to track. He won a seat on the board and signed a standstill agreement, but I suspect the pressure internally to sell will be intense as activist Joel Lawson won a seat last year and also favors a sale. Anchor trades right around book value and should command a decent premium in a takeover. The bank has an equity-to-assets ratio of 13.78, and non-performing assets are just 0.58% of total assets. Buyers would get a sound institution with about $430 million of assets, though total assets have declined over the past five years.

HopFed Bancorp (HFBC) , which is based in Hopkinsville, Kentucky, and has 18 branches, has also seen negative asset growth over the past five years. Stilwell also has a significant stake in this bank and recently sent a letter to shareholders indicating displeasure with both performance and management compensation. The bank has been trying to grow towards the more lucrative Nashville market, but I am not sure they will be able to do so fast enough to satisfy the activists and other shareholders who want to see a higher ROI. Non-performing assets have been ticking higher and now are 1.74% of total assets. They have plenty of capital with an equity-to-assets ratio of 11.3 and about $859 million in assets. For a bank looking to move closer to the magic $5 billion mark, HopFed trades right at book value. Selling should provide a decent upside.

ASB Bancorp (ASBB) , which has 13 branches, is in an attractive market in Asheville, North Carolina, a region that has seen a fair amount of M&A activity recently. They have about $804 million in assets, so they are the perfect size for a faster-growing bank aiming to expand in the state. Activist investor Lawrence Seidman gained two board seats earlier this year, and I suspect he is quietly pushing for a sale. Shares trade at about 1.1x book value and should fetch close to 1.4x book in a merger, so the stock has some upside potential if a deal is done in the next year.

There are dozens of smaller banks that need to consider a sale soon. The market is too competitive, interest rates won't rise soon and compliance and technology costs will keep rising. Most of these banks are too small to mention in this column, but it is worth your time to search for banks that have seen little or no asset growth over the past few years and have attracted the attention of at least one activist investor.

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