Take the Small Bank Challenge (No Ice Involved)

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.

If you are looking for small bank ideas to benefit form the trade of the decade try the Banking on Profits Monthly at the current introductory price

http://vip.marketfy.com/bank/

Clutter, OCD, Opportunity and Anticipation

It has been a busy week around Chez Melvin. I have barely had time to watch the Orioles whipping up on the New Your Yankees in the midst of all the chaos. We just put the August issue of the new monthly Banking on Profits together and it will be out tomorrow. There are various fed filings and 13D notices scattered all over the floor along with various earnings reports and research material. Of course tomorrow we have the regular Banking on Profits and Deep Value letters so we have stacks of earnings reports and valuation material laying around for those as well.

If that’s not enough to drive my mildly OCD wife over the edge it is 13F season as money managers of all stripes have until tomorrow to get their list of quarter end holdings in to the SEC. I am pretty old fashioned and have found enough errors at the popular tracking sites that I print out the reports and hand check them against the previous quarter. The wife has taken to sending the little one in to fetch if she needs me for any reason as the sight of all this clutter just might send her over the edge.

As I peruse the most recent filings one thing that stands out to me are that here is a ton of smart money selling going on out there. Tweedy Browne has been steadily lightening their positions not too long after admitting that they were carrying very high cash levels in their funds because they simply cannot find any bargains. Tweedy said in their most recent shareholder letter that ““We think of ourselves as being in the business of chasing value, not performance, and we do know that we have to pay, on average, a whole lot more for a dollar of value today. Our experience has taught us that if we keep looking, and exercise some patience, opportunities will turn up.” That sounds vaguely familiar to me.

David Tepper said back in June that the ECB moves made him feel better about the markets but he didn’t feel good enough to raise his positions much as his total equity exposure dropped by 21% form the March quarter. Third Avenue Funds appear to have been net sellers in the quarter as well. Wilbur Ross was a seller of common stocks in the quarter. Of course he recently said that even in his private equity operation he was selling six times as much as he was buying.

I don’t make market calls as you know but there a lot of very smart people are selling more than they are buying. There are still very few cheap stocks around and pretty much no new ones that we don’t already own in either the Deep Value Bundle or Banking on Profits. I keep looking all the time but we are not doing much finding. It reminds me of the late 90s and 2006 as to the lack of real safe and cheap opportunities. Of course I looked kind of stupid for an extended period of time then and I suspect that will be the case this time as well. I am quite content to sit here with my cash stockpile and wait until Iget smart again.

The real opportunity right now is in the community banks stocks. I own a bunch of them and in the portfolio we still have a bunch of adequately capitalized banks that trade around 80% of book value or so. Another dozen or so are just a small correction away from being too cheap not to own. Taking a long view of the sector consolidation is inevitable and those small banks that are not acquired are going to be those super strong local franchises that dominate their local market and churn out ever increasing earnings and dividends. It really is a win –win sector.

Consider this as well. Small bank shareholder bases don’t contain high frequency traders or swing traders. They tend to hold up much better in a bear market because its long term investors like me that own the shares as well as local business men and the officers and directors of the banks. In true panics they will take a hit as margin selling kicks in and investors have to sell their last quality asset to meet calls but that is

A.Rare; and

B. An opportunity of massive proportions

I have seen some massive opportunities in my career. Texas real estate when oil prices collapsed. The Junk Bond collapse of the early 1990s. Utility common and preferred stocks when nuclear costs over runs were crushing profits and balance sheets. Tech and telecom net-nets post internet bust. The S&L crisis. Japanese non-life insurers. Hotel REITs in 2009.Candian Government bonds pre-Nafta. Aircraft trust certificates in a bankruptcy of issuing airline. These were all huge opportunities and made smart patient investors a ton of money. This is as big if not bigger.

As we close out the week the Orioles are comfortably in first place for now and are heading to Cleveland tomorrow night and then onto Chicago for the Sox and then the Cubs. When all these filings are consumed I have a kindle full of great novels to read and Randy Wayne White has a new book out next week to which I am greatly anticipating. If you have never read his stuff go back to book 1 of the Doc Ford series and read forward. If you love good stories, good writing great character and solid plots you will thank me.

If you have never read my E-Book ‘Why isn’t everyone a value investor” you can get a copy free here

http://vip.marketfy.com/value-ebook/

If you are not a member of Banking on Profits to take advantage of the trade of the decade in community banks you can sign up for the regular service here http://www.marketfy.com/item/banking-on-profit/

Or the new monthly report here: http://www.marketfy.com/item/banking-on-profit-mon… The new issue is out tomorrow.

Cheers,

Tim

Song of the week. If you aren’t in the trade of the decade in small banks your shoud be asking yourself

Morons, Mark Twain and Good Reads

Ukraine, Gaza, Iraq, Interest rates, economic news, Ebola , weak earnings ,lower than expected housing, the hits just keep coming. The market is starting to remind me of the Larry Holmes -Tex Cobb fight as the world hits equity markets with every conceivable form of news that in days of yore would have sent prices tumbling. Fortified by ZIRP the market just keeps coming forward and doesn’t even stumble as it walks into punch after punch. We have seen some weakening of the knees in the past month but still no knockout blow that delivers and inventory creation event. I have been doing this for almost thirty years now and many of the recent news report, particularly the Ukraine and Iraq would have sent markets tumbling. Much like Cobb never quit no matter how many of those razor jabs and thundering hooks Holmes hit him with this market could care less.

As you know I do not make predictions about the market direction and have no clue what the market will do in the short to intermediate term. I do not think anyone else does either. I do know that I cannot find many cheap stocks outside of community banks, energy and mining sectors. You can start to feel pretty foolish sitting around with lots of cash in a strong market but it’s a feeling I have experienced before. In the late 1990s moron was one of the kinder words some clients called me for not getting into the can’t miss internet stocks. One client left me around then when a competing broker told him “ Don’t do business with that (expletive deleted) Melvin. All he buys is those little damned little banks and arbitrage stuff no one understands(liquidation arb was still pretty profitable back then).” My competitor was right. That’s was all I could find that was cheap and I had no intention of bending principles to conform with the fashion of the day. The client came back a few years later light by seven figures after all the cant miss internet and tech stocks did in fact miss.

I was called some pretty choice names in 2006 when I wrote in my blog” You might be able to sell me the fact that this market is fairly priced, providing I have been drinking heavily. But undervalued. I can’t see it. The bond market and the dollar are telling you it’s just not that good out there right now. We have rallied almost 12% since August without a real pause of any length and anybody who is not cautious now pretty much deserves what they get.” Clearly I do not understand the great opportunities offered by the new regime in housing gains and the new world of banking. I did know we could not find any cheap stock anywhere and even the quality little banks were trading ear twice book so cash levels were extreme. I did not learn any new words from clients then but I did hear several I had not heard in a while.

In the late 90s Warren Buffet was considered out of touch and too conservative to be relevant again. He has done pretty well since then. Julian Robertson walked away after investors turned on him for lagging the internet boom in 2000. He has not done so badly since investing in his own. Returns for value investors can be quite lumpy and you will find yourself out of step with the consensus. I am pretty comfortable with being out of step with the majority. They tend to be approximately right in the middle and devastatingly wrong at the tails of market movements. As Mark Twain once pointed out “Whenever you find yourself on the side of the majority, it is time to pause and reflect.”

Ben Graham once told us that “Wall Street people learn nothing and forget everything.” The lessons of Hetty Green, Andy Beal and Mr. Womack are rarely learned much less remembered by Wall Streeters and conventional investors. Big money is made by being there at the bottom with tons of cash to acquire assets on the cheap and not by searching around for todays hot stock and flip-flopping from security to security. The discipline says if it is safe and cheap, buy it. If you can’t find enough opportunities to be “all in” then don’t be afraid to hold cash. I do not know when we will get an inventory creation event but unless the world really has changed and it’s different this time we will get one.

We have found a few things and we have bought them. I remain excited about the little banks and own a bunch of them. The screeners run every day and I work through the filings and reports every day. If I can find it , I will buy it. And I will wait until the punches are too much to take and we get an inventory creation event.
While I wait there’s plenty to do in addition to searching and researching. We have some great baseball right now with some close races going into the home stretch. My Orioles are in first place in the AL East and hopefully close out a series win against Toronto tonight I am just finishing up the latest paperback Easy Rawlins novel by Walter Mosley and the new WEB Griffin was delivered today. I finished Back Channel by Stephen Carter last week and friends of spy and political novels want to read that one. To the dismay of the fast food joints and wine shops around here the wife is back from Texas and we are getting back into our normal summer routine
Cheers
Tim
Song of the week. When it comes to the markets I am a bit of this: