This morning I had my coffee while I was reading the latest edition of FIG Partners bank research. I have a great deal of respect for these guys and they are among the best when it comes to community bank stocks.
Today's report included research director Chris Marinac's "Themes for 2016" in the community bank space, and he had some very interesting thoughts worth considering. If he is right, our little banks and bubble banks are going to do very well and we should have solid returns again next year.
He expects merger activity to pick up and most of the action will be in smaller banks. He pointed out that the average assets of sellers was around $560 million in 2013 and 2014. In 2015, it has averaged around $720 million so far. Marinac says the overriding theme is still small bank consolidation and it always will be.
There may be some larger deals, but the real action will continue to be in the small banks trying to get the scale needed to deal with regulatory and technology costs. He also noted that the one day price-merger premium and price-to-book premium for acquisitions are rising slowly, but are nowhere near prior peaks.
Marinac also addressed the banks between $1 billion and $10 billion in assets. He believes many of these banks will "pull the ripcord" and put themselves up for sale. They will do that rather than deal with the big jump in regulatory costs that come with eclipsing the $10 billion level.
This brings a new level of banks to consider. We have the small have-to-sell banks and the bubble banks that are trying to grow into the sweet spot. Now, we add those between $5 billion and $10 billion in assets that have a big decision to make. I think the most money is going to be made in the " have to sell" and bubble banks. But we will keep any eye out for any big-decision banks that appear to be tired of all the regulatory pressures and costs that might just sell at a bigger premium.
My approach will be pretty much the same in 2016 as it was this year. I believe that if you find a small bank under $1 billion in assets with a strong balance sheet and pay less than 90% of book value, it is going to be hard not to make money. If you find one that also has at least one bank stock activist, or specialist, as a significant shareholder, then your odds of success go higher.
For bubble banks, we want financial strength and are willing to pay up to book value for these banks on the $1 billion bubble. They need to make some deals to get to the sweet spot of $3 billion to $5 billion in assets. If not, they will be acquired as someone else's path to the asset level where regulatory costs are less of a concern and margins are higher.
I am willing to pay up a little bit with the bubble banks and will go as high as 1x book value. While I will buy small banks without an activist on occasion, I believe with the bubble banks we will find that having an activist shareholder will be mandatory. There needs to be a force on management not to relax just because they reached the survival level.
A strong activist presence will make sure they either grow or sell and maximize shareholder value. There won't be as many attractive bubble banks. But I will be a buyer if we can find situations such as Charter Financial (CHFN), ESSA Bancorp (ESSA) and Shore Bancshares (SHBI) that fit my bubble bank profile.
Now, I am going to drag my soapbox out for a bit. If you are an individual investor and you are not buying the community banks, you are making a huge mistake. Most mutual funds, hedge funds and even traders I have talked to have struggled a lot this year. But I know that focuses on the small banks are up somewhere between 17% and 20% over the past year.
There is evidence that illiquid stocks and longer-holder periods raise returns over time. If you are still afraid to hold small banks in your regular portfolio, buy them in a retirement plan where liquidity does not matter as much. If you are doing well trading right now, take some of the profits and stick them into a portfolio of community banks and profit from the great consolidation trade.
We all have that investment or idea we passed on that we occasionally look back on and think: "Man, I really wish I had done that." Don't let the trade of the decade be that missed opportunity for you.