If you are bullish on the economy, you should avoid the Saint Louis Fed community bank survey at all costs. Bankers are the feet-on-the-ground of the U.S. economy, and their comments are a great way to measure economic activity. To say that most of them outside major urban areas are less-than-excited about global growth prospects is something of an understatement. I have been somewhat benign on the grand overview of the economy, and have maintained a better -- but not good -- view of the world for some time now, but this report made me feel like a Philadelphia Eagles fan questioning my baseless optimism, and searching for cheap tequila.
Major cities are seeing some decent activity and loan demand, according to the state-by-state Town Hall surveys the Fed did as part of its report. But the rural and suburban areas were seeing very little business improvement. In Alabama, bankers reported that new business development is limited-to-none. Arizona bankers told the Fed that the state's rural communities have seen only limited growth in new businesses. In the Northeast, Connecticut bankers reported that an uncertain business environment is creating a fear of job losses among major businesses, and the housing market is seen as unprofitable. I could go on, but it really doesn't get any better as you work further into the alphabet.
As I discussed yesterday, the bankers in the survey almost universally cited the costs of complying with all the new regulations as their biggest concern. They are also concerned about the rising costs of cyber security. This is a huge issue for banks, and these costs will just go up, as criminals -- and even hostile governments -- continue to hack away at bank databases in search of sensitive information. Bankers also expressed growing concern about competition from nonbank lenders that do not have the same regulatory costs and pressures as insured institutions.
While all this sounds pretty bleak, it is actually creating the best investment opportunity many of us will see in our lifetime. Banks are faced with weak economic conditions that make organic growth very difficult, and the smaller banks are finding it challenging to keep up with the rising costs of doing business. This is creating merger and acquisition activity -- as we have one group that needs to buy and another that needs to sell. According to a recent J.P. Morgan report, there have been 205 deals involving about $93 billion of bank deals done so far in 2015. There is every indication that this is picking up steam, as last week we had five deals announced on Monday, alone, and there have been several more since then.
According to the same report, the average multiple for a takeover deal is currently 1.37x book value. Although the bulk of the action is in the smallest banks, with the average deal size around $30 million, there are plenty of banks that are large enough to easily buy and tuck away for a trade-of-the-decade portfolio. Banks like Shore Bancshares (SHBI), Charter Financial (CHFN), ESSA Bancorp (ESSA) Northeast Bancorp (NBN) and Republic Bancorp (RBCAA) all have market caps over $100 million and trade for book value, or less. So do 2015 thrift conversions Beneficial Bancorp (BNCL), First Northwest (FNWB) and Kearney Financial (KRNY). All of these should be very rewarding additions to a long-term community-bank stock portfolio.
The best community bank hunting is going to be in the much smaller banks. It takes more work to dig out these little banks, and you surely will not be trading them. They are illiquid in nature, and will not fit well with anyone who is a fan of the current average holding period of 17 weeks for common stock positions. It can take weeks to buy a position, and you will never be able to sell the shares for a margin call or unexpected expense, so don't put short-term money in these banks. What they are is incredibly rewarding. In the past two weeks I have had two of these little banks receive takeover offers both resulting in gains of more than 70%.
I shout the small-bank gospel often, and I feel a lot like a an Old Testament prophet wandering the desert to point the way to milk, honey and profits to a populace more entranced by golden statues, high technology and ascending wedges. You don't have to just take my word for the opportunity in small banks. The Saint Louis Fed has spelled it out, chapter and verse, in its latest report on the community bank sector. Overlook this opportunity at your own peril.
