Today's column is something of a holiday gift. As we head into 2015, we are seeing improved conditions in the community bank sector and most observers expect to see a steady increase in mergers and acquisitions among the smaller banks. I consider this the trade of the decade, and it still has a long way to go. The recovery from the damage of the credit crisis has taken several years but we are now seeing healthier loan portfolios and higher capital levels across the sector. The banks that have survived the worst of it have, for the most part, emerged stronger than ever. These improvements are leading to dividend increases and stock buybacks for many of these little banks. Many of the stock are still very cheap and this is attracting increased attention form activist investors, which is a huge potential bonus for current investors.
M&A activity is going to pick up this year, driven by the rising costs of regulatory compliance due to new regulations intended to prevent another crisis. The regulations will not achieve that lofty goal but they have forced many smaller banks to consider selling to spread costs over a larger asset base. Boardroom fatigue will play a role in M&A as well, as many executives have just experienced the most brutal five years of their careers. Small-bank officers and directors are usually large shareholder, so if they can get an attractive price that allows them to cash in and get out from under the regulatory and economic pressures of running a smaller bank, they may be more amenable to selling than before the crisis.
Finally, the smaller regional banks are finding it very difficult to grow profits in the highly competitive banking world of today. The top five banks control 45% of the deposit market, leaving a whole bunch of banks fighting for a smaller piece of the pie. The most efficient, least expensive way to find earnings growth is to buy a smaller bank that increases your footprint and earnings power.
Yesterday I sat down with Nate Tobik of CompleteBankData.com and used his database to search for perfect bank stocks. I define a perfect bank as a one with an equity-to-asset ratio over 10 (more than twice the level Peter Lynch once suggested was adequate), nonperforming assets that are less than 2% of total assets and a stock price that is below 85% of tangible book value. We found a bunch of these stocks but most are too small to mention aloud without distorting the market. However, we did manage to find three perfect bank stocks for you to consider for your 2015 portfolio.
Eastern Virginia Bankshares (EVBS) is one of my favorite little bank stocks. It's based in Tappahannock, Va., along the Rappahannock River. As of last quarter, Eastern Virginia has roughly $1 billion in total assets. The bank has had a big year in 2014. It repaid $10 million of TARP money and completed the acquisition of Virginia Company Bank, a move that increases exposure to the growing Tidewater region of Virginia. The stock trades at 75% of book value so it is certainly cheap. The bank's nonperforming assets are just 1.05% of total assets and the equity-to-assets ratio is a comfortable 11.20. The bank has a formidable shareholder list that includes EJF Capital, FJ Capital, Basswood Partners, Banc Funds LLC and Arbiter Capital.
Northeast Bancorp (NBN) has 12 branches and about $779 million worth of assets in the booming metropolis of Lewiston, Maine. The bank has seen solid loan growth primarily from commercial loans purchased or originated by the bank's loan acquisition and servicing group. That division of the bank purchased more than $70 million of loans in the third quarter alone. The stock trades at just 83% of book value and the bank is in solid financial condition with nonperforming assets of just 1.2% of total assets and equity-to-assets ratio of 12.81. The shareholder list is not quite as formidable as Eastern Virginian's but Michael Price and LSV Asset Management both own shares of the bank.
MBT Financial (MBTF) is located in Michigan and has 24 branches with about $1.2 billion in total capital. The bank has been focused on cleaning up its balance sheet and selling troubled assets. As a result, nonperforming assets have fallen from 5.71% of total assets three years ago to just 1.55% today. The equity-to-assets ratio is 10.2 and the stock is selling for 84% of book value, so it comes in under the perfect stock bar. It has a shareholder list that looks a bit like a bank stock investor and activist hall of fame: FJ Capital, Banc Funds LLC, Basswood Partners, Castle Creek and Patriot Financial all own shares.
Tracking the perfect bank stock should be a regular part of your research activities in 2015, as the trade of the decade is alive and well. These three stock should lead the way.