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

Good Investments in Small Packages

Some of my cheap, well-capitalized banks are attracting attention from quantitative and statistical types, which is typically an encouraging sign.
By TIM MELVIN Oct 26, 2012 | 04:30 PM EDT
Stocks quotes in this article: ESSA, HBOS, WFD

Before we head into the weekend, I want to finish my series on bank stocks by going over a few others that are worth attention. These are the banks that I like and have been buying for myself and clients. I worked for years at a firm that made a market in regional and community bank stocks and learned a lot from the traders and analysts who covered the group. Most of my picks in this area are far too small to talk about on Real Money, but I do have a few that may interest readers.

At first glance, Heritage Bank of the South (HBOS) has rising loan losses. It looks like nonperforming loans have risen sharply, year-over-year, when you look at the FDIC report. However, a look inside the numbers shows a much brighter picture. The bank has done several FDIC assisted transaction in the past year and the bulk of the nonperforming loans are part of FDIC assisted transaction and about 80% of potential losses are covered by the regulators. The non-FDIC assisted portfolio had a non-performing loan ratio of just 1.68 % in the latest report released yesterday.

The branch bank is seeing solid results in one of the hardest hit real estate markets in the U.S. Heritage has 23 branches, 11 mortgage office and four investment office in South Georgia, North Florida and eastern Alabama. The ban has been opening and buying new branches to extend it footprint in the market place and us seeing decent loan growth in its core markets. With a loan to depots ratio if just 70% the bank has room to expand it balance sheet and grow its earnings base over the next few years. With the shares trading at just 90% of tangible book value and a tangible equity to assets ratio over 11, I think the stock is an attractive buy for long-term investors. I am also not the only who thinks so, as 27 different investment funds were buyers of the stock in the second quarter.

I remain a fan of Westfield Financial (WFD) as well. This Massachusetts-based bank has $1.3 billion of assets and operates 12 branches. The loan portfolio is sparkling clean and includes  a non-performing loan ratio of just 0.47%. This bank has been more than cautious, with loan loss reserves that are 3x the current non-performing loan portfolio. The shares trade at less than 90% of tangible book value and they have a tangible equity-to-assets ratio of over 15. Management recently announced a new repurchase program and their intention to buy back another 5% of the outstanding shares. This bank is also attracting institutional interest, with 35 funds buying a total of more than a million shares in the second quarter.

Institutional investors bought twice as many shares as were sold by funds of ESSA Bancorp (ESSA) in the second quarter. We originally got this idea from our friends at FJ Capital and I still like the stock quite a bit. Noncurrent loans are just 2.10% of total loans and total non-performing assets are just 1.93% of the total asset base. The bank has a tangible equity-to-asset ratio of more than 10 and the stock trades at less than 80% of tangible book value. The company announced the closing of a deal to acquire First Star bank, which will increase its presence in the Pennsylvania market. The deal increased the bank's asset base by almost 30% to a little over $1.4 billon.

While perusing the institutional buying and selling of small bank stock in the second quarter, I noticed that quantitative and statistical types, such as Jim Simons of Renaissance Technologies and the D.E. Shaw Group, showed up as large buyers of many of the stocks I am watching. I am nowhere near smart enough to figure out what goes into their algorithms, but when I have seen the quants buying value stocks, they rallied shortly thereafter. Hopefully, this will play out for the cheap, well-capitalized little banks as well.

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At the time of publication, Melvin was long ESSA, HBOS and WFD.

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

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