originally published on RealMoney.com
I first started trading community bank stocks and buying them for clients in the aftermath of the securities-and-loan (S&L) crisis in the early 1990s and I have been actively involved in the sector since then. It has been an incredibly profitable sector over the two years.
I love finding cheap little banks with huge upside. I often refer to these little gems as the most boring way to get rich in the stock market. Of course, the opportunity is greater than ever today as many small bank stocks are still very cheap in the aftermath of the credit and real estate crisis.
I think these little stocks are in fact “the trade of the decade” and they could be life changing over the next 10 years for investors who add this sector to their portfolio. I am honestly puzzled that they haven’t attracted more investors, as it seems pretty obvious to me. Why individuals would prefer chasing hot stocks to profiting from the inevitable mergers-and-acquisitions (M&A) wave in community banks is beyond my understanding. But year-in and year-out, I see the same handful of people involved in the sector, buying up the small banks and making big profits from their endeavors.
For some time now, I have been reading some of the bank stock musings of Phil Timyan, a retired fund manager who is still very active in the smaller banks. Timyan had a great career as a broker at Oppenheimer back in the wild west days of the 1980s when junk bonds and LBO’s were invented and was an analyst at well-known short seller hedge fund Feshbach Brothers for a while .
He ran two hedge funds of his own and became attracted to the sector when he noticed some mutual conversions trading at ridiculous price-to-book value ratios and small community banking organization that were illiquid and priced for extinction. He has been actively involved in the sector every since and is on the board of two small banks in the Chicago area. Currently, he writes a blog about small banks and invests his own money in cheap little banks he finds. I had the pleasure of spending some time on the phone with him yesterday and got his insights in the current environment in the small bank sector.
His views are not terribly different than my own. He called the small banks “the investment of a generation” at current levels. As an insider, he has a more in-depth view of what is going on in the banks and told me that the management and board fatigue is widespread in small banks. After five years of bad loans, workouts, audits and building customer discontent with everything banking, these folks are just tired. If they can get a decent price they want to sell. Timyan thinks we are in the every early innings of very long and profitable game in the community banks. The combination of recovery and takeovers should lift the current valuations higher by several multiples over time.
He also had some interesting thoughts on banking as a whole as well as something of a challenge for investors. He pointed out one small bank in the Portland Oregon are that is a solid little institutions with about $240 million of deposits. Within one mile of their main office the big banks have locations with more than $10 billion in deposits. If just ten percent of that money was moved to the local bank it would grow in size by fivefold and profits and the stock price would soar. He also points out that the local banks add far more value to the community than the big guys, usually pay a little higher rate on deposits and most likely have much better service for customers.
I thought about this in the context of some of my favorite little banks. Prudential Bancorp (PBIP) has more than $30 billion in big banks deposits within a reasonable distance of their main branch. Just a fraction moved over to the $450 million bank would be an enormous boon to the long-term performance of the bank. Charter Financial (CHFN) has about $80 million of deposits in its service area — the big banks have more than $80 billion in deposits in the region. Just a 1% shift from the big guys to the little guys would double the size of the banks and higher profits and stock price for the bank.
So this leads me to what I am going to call the Melvin-Timyan Challenge for investors. Pick your favorite small bank in your area. Make sure the financials are solid. Buy a few thousand shares of the stock. Move all your personal and business banking accounts and give them as much of your loan business as possible. Convince your friends to do the same. Enjoy better rates, better service and make an enormous amount of money as the flood of money from the big guys to the little guys drives your stock price many multiples of the current price over the next decade.
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