Next Thursday marks what I consider the official start of the holiday season. Although I try each year to hold off the ho-ho-hoing around Chez Melvin until then, it is a losing battle. As I write this, my wife is inventorying décor upstairs, and I am sure she is listening to Christmas music while sorting the oversized supply of tchotchkes. I am sure she conspired with my friends at FJ Capital Management in Northern Virginia, because they sent me a lovely pre-holiday gift last night.
I was delighted to find FJ Capital's latest U.S. Banking Sector M&A Quarterly Digest in my in-box. It was just what I needed to get me a holiday mood.
I have followed the buying and selling of these community bank stock specialists for some time. Over the years, they have been generous about sharing their insights on the sector with Real Money readers. These are smart folks who have a fantastic track record investing in my favorite sector, and investors looking for trades of the decade would be wise to pay attention to the firm's buying and selling.
In their latest M&A review, they point out that the merger wave is continuing to build among the small banks. According to their report, 69 M&A transactions were announced in the third quarter, vs. 80 in the second quarter, and sixty‐two in the third quarter of 2013.Total deal value is $5.8 billion in the third quarter of this year, compared to $3.4 billion in the second quarter and $7.3 billion in the third quarter a year ago. Year-to-date, we have seen 207 deals with a total value of $11.3 billion in the community bank sector.
The firm noted that the recent BB&T (BBT) deal to buy Bank of Kentucky (BKYF) is a potential watershed event. This is the first whole-bank acquisition involving a U.S. bank with more than $100 billion in assets. If the large regional banks are getting back into the M&A game, using their shares as acquisition currency to buy the smaller banks, we would see serious fireworks over the next few years.
FJ Capital also pointed out that we had the largest year-over-year decline in the number of bank branches in the U.S. since 1992. This is fueled not just by consolidation but technology progress that allow for more online banking options. Over time, this has reduced the need for brick-and-mortar space. This should improve profitability for the smaller banks, and that should lead to higher stock prices.
The average deal multiple of book value rose to 1.45% in the third quarter of the year. However, this number distorted by the difference between prices paid for high performing banks, as opposed to the prices paid for weaker performers. The banks with ROEs over 10% got an average premium of 170%, while those earning less than that received a premium of 117%. This is critical. Those banks trading below book value that can improve their ROEs by improved credit conditions and loan mix should see both their book value and deal multiple go up in a double-compounding effect.
FJ capital's 13F filing was one of the first such filings I pulled, before the deadline earlier this month. These guys are good at spotting the developing trends in the small-bank space, and they are even better at identifying the stock that will benefit from developing events. I was happy to see that one of the firm's biggest buys in the past quarter was in shares of Sun Bancorp (SBNC) of New Jersey. I bought shares of this when Wilbur Ross bought shares, and I have done well with the stock, but there is a lot of upside left in this stock.
FJ Capital also joined the parade in buying shares of the recent second-step conversion bank, Meridian Bancorp (EBSB). Post-offering, this a very clean little bank with nonperforming assets of 0.94% of total assets, and an equity to assets ratio of 18.4 The stock trades a little over book value at the moment, but I would be a buyer should it pull back.
Investar (ISTR) is a 10-branch bank in Baton Rouge, Louisiana. It has about $783 million in assets. FJ capital was buying this stock in the third quarter. They are also a very clean little bank with equity to assets ratio of over 16 and nonperforming asset of just 0.57%. With the shares trading below book value, the stock is worth considering for a trade of the decade portfolio.
Merger activity is picking up in the small bank sector, and it looks like we could see the super regionals getting back into the game, as we approach 2015. Tracking the filings of successful bank stock investors like FJ Capital is a great way to find ideas that allow you to participate in the trade of the decade in small stocks.
If you would excuse me, I have to go look for my Dean Martin Christmas albums.