2016: Great Expectations

2016-new-year

Banking on Profits main portfolio is up 17.2% this year. We have participated in multiple takeovers during the year. We have two stocks down on the year with the biggest declining stock down just 2%. Bonus bank stock picks have averaged 20.47% over the past 52 weeks. As a holiday special you can get a full year for 20% by clicking here and using coupon code BOP23

Don’t take my word for it- Look what the bankers, lawyers, brokers and rating agencies are saying abou the trade of the decade in community bank stocks.

Why are they shrinking?
The banking industry and regulators cite a variety of reasons, including:
▪ During this era of low interest rates, banks are having a hard time growing their net interest margins, the difference between what a banks pays on deposits and receives for loans.
In addition, loan growth remains challenging while the economy is still recovering.
Those factors are motivating some banks to grow and improve their profitability by other means, such as through mergers and acquisitions.
▪ Banks are facing rising costs from new regulations and the need to spend more to bolster their mobile-banking platforms and cybersecurity. By merging, banks can gain economies of scale to absorb such costs. -Charlotte Observer

Look for BB&T to continue to pursue acquisitions during 2016, BB&T CEO Kelly King has said. “So that’s $10 billion to $20 billion (in acquired assets) in a year,” King said during an investors call in July, recounting recent acquisitions. “I feel confident in that same category range for next year. There are a number of institutions, let’s just say in the $5 billion to $20 billion range, that I think are considering their strategic opportunities and may present some availabilities.”-Triad Business Journal

As of early December, there have been just under 250 Bank & Thrift M&A deals in 2015 with a $742 Million average Asset size at the Seller. There were 267 transactions in 2014 and 209 in 2013, both with Sellers just over $560 Million in average Assets. It is less important that the average Asset size is higher—the percentage of deals above $1 Billion consistently has been around 10%. Big Bank M&A is not the trend and this was true back in the late 1990s (see our charts here). In 2016, we expect M&A deals to increase, but the Sellers’ size is unlikely to change much at all. Small Bank consolidation is the real trend — frankly, it always has been. Although some larger institutions may merge, we feel the large Bank deals such as FNFG-First Niagara and AF-Astoria Financial in the past few weeks (Fall 2015) are quite unique. The clearer trend is that small Banks continue as the most active sellers.- Chris Marinac FIG Partners.

As banks grapple with the cost of regulation and soldier on in the lower-for-longer interest rate environment, banks’ net interest margins and profitability will be pressured, which we expect to lead to M&A in 2016.” “Even with steady capitalization levels, U.S. bank earnings will be challenged next year due to economic headwinds and the strengthening dollar,” said Christopher Wolfe, Managing Director Financial Institutions at Fitch Ratings. “As banks grapple with the cost of regulation and soldier on in the lower-for-longer interest rate environment, banks’ net interest margins and profitability will be pressured, which we expect to lead to M&A in 2016.- Fitch rating agency
Jimmy Dunne, co-founder at Sandler O’Neill & Partners, went on Bloomberg late last week and replied “absolutely” when asked if regional banks’ M&A would continue. Dunne said that conditions were ripe for continued activity and that it was not a case of “I think it is going to happen. It is going to happen”.- Real Money
“We recommend investors also consider allocating capital to M&A as the building momentum is also likely to be a profitable investment strategy. In the face of somewhat elevated multiples and relatively-stagnant profitability metrics, stock selection, both fundamentally and M&A-based, should provide the backbone of investor returns in 2016,” the firm also said.-KBW

With total bank capital at the highest level in many years and bank earnings continuing to recover, I predict that there will be in excess of 400 unassisted bank mergers in 2016. This will be the highest total of mergers since year 2000.” -— Mark W. Olson, Chairman of Treliant Risk Advisors and former Federal Reserve Board governor.
“In at least one quarter of 2016 — and quite possibly the entire year — the industry will see for the first time the number of bank charters shrink on an annualized basis by more than 6%. As a result, investor interest in the banking sector, and most specifically in smaller regionals and larger community banks, will spike to levels not seen since well before the financial crisis.”— Richard J. Parsons, former executive at Bank of America and author of Broke: America’s Banking System

Nutter McClennen & Fish says it has either closed or advised on eight New England bank mergers in 2015, a record for the Boston law firm. Kenneth Ehrlich says new Dodd-Frank requirements for local banks are a driving force behind the uptick in mergers, as an increasing number of community banks — particularly those where the CEOs are retiring — look for the safety of a bigger partner. “There’s a certain amount of governance fatigue,” says Ehrlich, who runs Nutter’s banking practice with Michael Krebs. “The visceral reaction [against mergers] has lessened.” – Boston Globe

The Trade of the Decade is here. Its real and happening now. Get Banking on Profits for 20% off here. We are up 17.2% in 2015 and expect a better year next year. Use Coupon code BOP23

Fitch Ratings 2016 Bank Outlook

Second_Bank_of_the_United_States

NEW YORK–(BUSINESS WIRE)–Healthy capital and liquidity levels, still benign asset quality and generally improving profitability, albeit below pre-crisis levels, contribute to a stable 2016 ratings and sector outlook for U.S. banks, according to Fitch Ratings’ 2016 U.S. Banks Outlook Report.

“As banks grapple with the cost of regulation and soldier on in the lower-for-longer interest rate environment, banks’ net interest margins and profitability will be pressured, which we expect to lead to M&A in 2016.”
“Even with steady capitalization levels, U.S. bank earnings will be challenged next year due to economic headwinds and the strengthening dollar,” said Christopher Wolfe, Managing Director Financial Institutions at Fitch Ratings. “As banks grapple with the cost of regulation and soldier on in the lower-for-longer interest rate environment, banks’ net interest margins and profitability will be pressured, which we expect to lead to M&A in 2016.”

The pace of industry consolidation will increase in 2016 due to the need for greater scale efficiencies from costly compliance with financial regulation, technology investments, and the prolonged low interest rate environment not being sufficient enough to improve profitability. Achieving scale is even more important, as banks will have fewer reserve releases to flatter the earnings picture in 2016.

Even as interest rates rise, the slow and incremental increase will not be enough to boost profitability for banks in a meaningful way in the short term. Bank earnings growth is expected to be somewhat muted given the expectation of rising provision expenses, limited improvement to margins over the next 12 months, and continual compliance and regulatory-related investments.

It is Fitch’s view that the bank regulatory agenda is nearing completion and bank management teams will prioritize implementation and compliance in the years ahead. Fitch expects that U.S. and foreign bank-owned entities will have sufficient time to comply with new structural, capital and liquidity rules ahead of schedule.
New market entrants including “digital wallets” and technological advancements such as “block chains” from non-bank competitors will continue to threaten banks in 2016. Non-bank lenders do not have to comply with full and costly bank regulation and, as online lenders, do not have to contend with the physical costs of retail branches. Some more traditional banks are trying to overcome the competitive threat by partnering with marketplace lenders, a trend that will likely continue in 2016.

Additional information is available at www.fitchratings.com

2016 Outlook: U.S. Banks (As the Credit and Rate Environment Turns)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=874998

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY’S PUBLIC WEBSITE ‘WWW.FITCHRATINGS.COM’. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE ‘CODE OF CONDUCT’ SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

I am not the only one that see bank M&A continuing. Ratings agencies, law firms, brokerage firms, and bankers themselves are talking about the M&A trend and the acceleration we should see in community bank M&A in 2016. We have a strong 2015 and it looks like 2016 will be even better.

Banking on Profits Monthly can help you get started finding the community bank stocks that have the potential to be winning stocks in 2016. You can sign up for just Banking on Profits Monthly here for just $199 or you can get a full year of my Deep Value letter for 30% off and get Banking on Profits free for a year by clicking here and using coupon code DVBOP

Barroom Bets, Shrinking IQ and Rock and Roll

gator claus

Fed day is finally behind us and we can now move on feom will they to how often will they raise rates. The amount of talk and wagering surrounding the first rate hike since 2006 has at times reminded me of my trips to Keeneland race track in Lexington, Ky for the Bluegrass Stakes race. The Bluegrass is a big pre Kentucky Derby race and a bunch of us used to go down every year. Sitting around McCarthys Saloon we would talk about which horse would and which horse wouldn’t and make some faulty complex bets based on what was at best bourbon fueled confusion. The week leading up to the Fed decision reminded me very much of those evenings. All that was needed was some Woodford Reserve and cigar smoke.

With the Fed raising rates I suspect we now hear lots of mentions of Marty Zweigs don’t fight the fed theory that has been so spectacularly proven over the past 6 1/2 years. If the Fed is lowering rates own stocks and if they are raising them sell stocks. Zweig made a ton of money for himself and investors with that advice over the years. It’s too soon to tell as there is still a strong contingent of those who think that the economy is not strong enough to handle a sustained strong of rate increases. Count Jeffrey Gundlach of Double Line who told CNBC an hour before the hike was announced that the economy had weakened since the last meeting and raising rates was a mistake He suggested a portfolio comprise primarily or REITS and discounted closed end funds. We have a lot of those in both Deep Value and value Income so we will not be sad if he turns out to be 100% correct.

As oil as continued to plunge we have taken a final year end beating in our energy related stocks. The one month returns on these stocks is just horrible. This afternoon I went in and read the Value Line reports for the energy stocks in our portfolio that are covered by the service. The reports were all similar and said something along the lines of bad short term outlook with enormous upside potential over the 3 to five year period. The expected returns average 148% on the low end of anticipated range to an average of 308% on the high side. I have been long and wrong so far with oil but the pendulum will swing the other way at some point and we will staggering advances for the current price of these stocks. We have also seen what I suspect a lot of tax loss selling in some of our stocks so I am not going ot be surmised if we see something of a January effect in the portfolio in the new year.

I am pretty sure we are getting closer to the point where value investing takes the lead again. I am starting to get the emails about what a moron I am and how deep value no longer works. It remind some of the calls I got as a broker in 99 and 07 when we held a lot of cash and the stocks we did own were simply not working. While I freely acknowledge the pain of the Deep Value portfolio it seems the fact that I have suggested a 70-30 mix of community banks and deep value all year is forgotten. That mix has returned about 4.5% this year, or more than 4 times the admittedly paltry return of the S&P 500. When I start seeing the accusatory emails and calls I can be confident that the turn is near. I am in pretty good company as Mason Hawkins, Carl Icahn, Tweedy Browne, David Einhorn, Bill Ackman and a whole bunch of other formerly smart people are now at least as dumb as I am this year. I suspect we will all look a lot smarter in a year or so.

Around Chez Melvin we are gearing up for a painful election year. We live in a swing state and the advertising barrage will be brutal until the primary is over here in Florida on March 15th. We will then get about a day and a half before the special interest groups begin the barrage about ballot issues and then after the conventions the general election candidates will buy up every second of airtime. If you don’t live in a swing state I can tell you that by about mid-September you really miss the incontinence and erectile dysfunction ads. I try to avoid politics for the most part in my newsletters but I think this may end up being one of the more brutal and mean spirited campaigns of my lifetime and there are going to be a lot of plans, promises and attacks that can move the market around in 2016.

I continue to favor the community bank stocks as we head into the New Year. The M&A trend is going to accelerate as everyone under $1 billion is vulnerable because of regulatory costs, technology costs and a slow growth environment. The bubble banks between $1 and $2 billion will come into play this year as they look to grow or buy their way into the $3 to $5 billion industry sweet spot. More than 85% of bank over $5 billion of assets have said they are looking to buy a bank this year. About 70% of those between $1 and $5 billion are on the hunt takeover candidate. Most of the bank CEOs below $1 billion in assets are well aware that they need to grow and grow quickly. The only way to grow is to buy so its going to get busy and should make us a lot of money again in 2016.

Don’t forget that this month only you can get Deep Value for 30% and get a year of Banking on Profits free. Sign up here and use coupon code DVBOP.
This time next week will be Christmas Eve so don’t expect to hear from me. I will be cooking up dinner for a bunch of folks and getting ready for the traditional Melvin open house party on Saturday.
Happy Holidays everyone.

Tim

Lets all have a

Illiquidity, Barbed Wire and Holiday Music

illiquid

A kind soul on twitter sent me a study the other day by Thomas M. Idzorek, CFA, James X. Xiong, CFA, and Roger G. Ibbotson that studied liquidity in the equity market. Want to guess what they found? The same thing they found every other time it has been studied. This studied mutual funds and they found that mutual funds investing in illiquid stocks beat those that favored more liquid issues. Further more those that had a value bias and bough illiquid stack best the ants off everything else out there. The study concludes “Overall, the liquidity investment style is clearly present in mutual funds and leads to dramatic differences in performance.” This is similar to the earlier Ibbotson study that found that illiquid value stocks crushed liquid growth stocks and the market indexes.

So we know it works. Stretch out time frame a bit, quit trading and own a portfolio of undervalued illiquid stocks and beat the market by a wide margin over time. A lot more naps and a lot less screaming at screens and throwing coffee cup across the office. It is good for everyone but the manufacturers of stress balls and coffee cups. It works. We know it does. It has been proven in theory and practice. Yet no one does it.

The want the liquidity to get in and out on a moment’s notice. Gotta be able to hit that bid baby. Ben Graham once said that investing works best when it is most business like. What in the world is business like about short term trading. What other capital asset would you demand provide you instant liquidity? Can’t do with a house. Can’t do with a private company, a tract of land, an office building and other investments but when it comes to fractional ownership of a corporation you need to be able to get out anytime everyday?

Folks tell me all the time I want to be able to get out if the market goes bad. I hate to tell you this Chicken Little but that is costing you a ton of money. The study also found “Surprisingly, the outperformance of the mutual funds that hold less liquid stocks was primarily due to superior performance in down markets. One possibility is that during periods of turmoil, high liquidity managers may be more likely to trade; thus, the most liquid stocks may, in fact, suffer the steepest declines because there is a greater propensity for their owners to trade them.” If it is difficult to see there is a tendency to hold the sock and just ride it out. Since most shareholders of an illiquid stock will have the same opinion there is a lot less selling pressure.

Think of it this way. You have two big jars of money. Every year the current balance of the jar will be increased by about 8% at the end of each year until you retire. One jar is easy access. Open the jar any day, take out the cash and be on your way. That’s liquid stocks. To open the other jar you are exposed to an electrical shock while in contact the lid. One the lid comes off you have to stick your hand thought a small hole with jagged edges wiggle your hand enough to unwrap the barbed wire that the cash will be wrapped in to take out what you wish to spend right now. That’s illiquid stocks. They are hard to sell and the costs of trading them can be quite high due to the wider bid ask spreads. When it comes time to retire which jar do you think will have the most money in it?

Mow figure that as Mr. Ibbotson found the easy open jar grows by the market average rate of return of roughly 10% but the ragged edge, electro-shock barbed wire jar grows by 18% a year? That’s illiquid value stocks versus the overall market. Quit avoiding illiquidity. It is your best friend as a long term investor.

Thus endeth todays lesson.

I am spending part of the evening at a middle school Holiday concert and event that has all the appeal of nice cool cup of ground glass but off I go anyway. It is what we do as parents and why we have wine. Mayve I will get lucky and the late edition of MLB Tonight will finally report that Bryce Harper and Mike Trout have been traded to the Orioles.

Enjoy the week.

Tim

If I have to listen to Bad Christmas songs tonight you should as well!

Santa’s Offer You Can’t Refuse

santa

I am on a lot of email lists and apparently I am supposed to have a Holiday special offer for my newsletters. I am horrible at the marketing stuff so I figured if I am supposed to then I will.

I expect the market to run back towards to the Deep Value Approach with spectacular results in 2016. I have seen this movie before and when a market gets as old at this at 80 months old- the average bull market is 51 months – the odds of a correction rise. In is during a market correction and the early stages of a recovery that deep value really shines and the returns in the past have been extraordinary. Because the market is so rich we have about 50% cash in the Deep Value Portfolio so we are prepared to take advantage of any market weakness. In addition we are over invested in energy stocks so if we get even a hint of an oil rebound subscribers are going to make a ton of money in 2016 with the Deep Value approach.

Of course if you did as I have suggested all year and combined a deep value portfolio with a community bank only portfolio you are actually beating the market in 2015 with a cash hoard of over 25%. Community banks are in a huge consolidation phase and most bankers expect to continue and accelerate in 2016.

So here is what I am going to offer this Holiday Season. Deep Value is usually $399 a year. I am going to lower the price to just $279 for December, a saving of more than 30%. Then to sweeten the offer and get you involved in the trade of the decade and understand the powerful economic , regulatory and demographic issues that will push community stocks higher for years to come I will throw in a free year of Banking on Profits Monthly.
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With Banking on Profits Monthly will provide you all the information needed, in one easy-to-read monthly report, to stay on top of the entire banking sector and sift out the massive opportunities produced from the “Great Banking Consolidation.” I will keep you informed on where the insiders and bank stock activists are buying and provide focus stock picks in each issue. There will be commentary on the industry and the economy. I will have interviews with bankers and fund managers who invest in the bank sector. You will get what you need to start participating in the trade of the decade.

I figure if I am supposed to make a Holiday offer I should make it a good one.
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Happy Holidays
Tim

Oil (again), Banks (again) and Spanish Pipedreams

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I couldn’t help myself. I really did not want to do it. Circumstances forced my hand. I bought another energy related company today after they (shocker) missed earnings forecast. This firm I bought on the services side of the coin and not E&P. The stock is literally too cheap not to own and the margin of safety is huge so I had to buy it.

We have been looking for place to double down and lower our cost basis on our other energy holding but I am still hearing way too many folks talking about the enormous opportunity in energy stocks from this level. There is not quite enough blood, vomit and general gnashing of the teeth for me to feel like we are closing in on oils low water mark just yet I am well aware that Saudi Arabia needs something like $85 a barrel to balance its budget but as long as they are getting more than $27 they are not losing money. I think it is when they get close to them losing money for every barrel out of the ground that they will be forced to consider a policy change. Closer to $30 and we will start to see the type of margin calls, broken levers and trophy divorces that mark a buyable bottom that allows us to double down and possibly take on more positions.

It is worth noting that at the OPEC meeting there are signs that not everyone want so to play the market share game much longer. Even as the official form the UAE said that they would be increasing production Oman oil minister Mohammed bin Hama al-Rumhy said “This is a man-made crisis in our industry we have created. And I think all we’re doing is irresponsible.”

On the happier side of things the Bank Director M&A survey is out and it is still a pretty rosy picture for community bank M&A activity. The majority of respondents believe that the outlook is getting better and most think they need to grow their bank a lot faster to achieve scale that allows costs to be reduce as a percentage of revenues. The smaller banks feel that they must get above the Billion dollar mark and from my chair the only way to accomplish that in anything close to a reasonable time frame is to buy another bank. That should bode well for us.

If it seems that I spend a lot of time talking about small banks and oil stocks itis because I do. That’s what cheap right now so it is where I am spending a god deal of my time. One of these focus areas is working very well as expected and one not so much. While some measure of that is to expected we may have an answer to this all too zig and zag familiar problem for value investors from a most unlikely source . The answer may actually come from price momentum. I spent some time recently working on a combination of deep value asset based investing with dual momentum and it actually help significantly in avoiding disasters. I wrote about this and Real Money today and said that “One reason for the outperformance is that this model portfolio sidesteps disaster. The portfolio owned no tech names in 2000, no banks in 2007 and no energy in 2014 and 2015. Because the performance has to be positive over the past year, it does not get caught owning stocks that have simply gone down less than the market.”

Lots of studies have been conducted on the combination of value and momentum but most of them used decile comparison or of late the value and growth ETFs. I have never seen just the absolute values of price to book value and an advanced concept of momentum combine to manage a portfolio and I think this approach has significant value and I will be exploring this a lot in the days and weeks ahead. I may even go round up a couple of MBA kids who want to work on an expanded project on the subject.

I am in Kindle heaven as the holiday season approaches and the publishers are rolling out tons of titles evey week. I am spending all my time not researching, testing or searching for stocks and strategies on trying to stay head of the weekly Tuesday new book dump. So far I am keeping ahead but a look at the weeks ahead tell me I may have to find another hour or two a day to keep even. Although most of my off hours reading is recreational I think that, given the times we live in, that Thomas Jefferson and the Tripoli Pirates: The Forgotten War That Changed American History by Don Yaeger to be a potential great read as well and will cracking it open this weekend. Give books this Christmas and make the world a little better – and more literate place. If you have stacks and stack of book around the house as I often do consider packing them up and shipping them to http://www.bookthing.org/ or find a local equivalent.

Make a note that next week is a full on publishing Holiday. Long time subscribers know that when I have all the kids together we take a publishing break unless something spectacular happens. With my oldest married and living in Chicago and my son getting very career focused down here in Orlando it just dent happen that much. So no letter, weekly updates or anything else after Wednesday next week unless there is a major event. Give that it is the only holiday each year that features win, excessive food consumption with no gift giving required I suggest you folks do the same.

Have a great week everyone

Tim

As we head into Holiday Season keep in mind what’s really important and that its all just a