Investing in community bank stocks has been the most lucrative approach to the stock market that I have used in my career. These little banks do not have derivative portfolios, they tend not to make exotic loans or engage in investment banking or trading. They take deposits and they make loans. They lend to individuals, small businesses, commercial real estate, education and other traditional lending activities. For most of my career, they have been solid long-term investments.
Community banks are made more attractive by the fact that the universe of small banks has been shrinking for decades. When Congress, in its infinite wisdom, began to relax and eventually remove the interstate banking laws, there were about 18,000 banks in the United States. Those banks that wished to expand found it cheaper to just buy banks in neighboring states than try to build out a branch network. As a result, there are about 6,000 banks and the consolidation trend is accelerating.
Now there is added pressure on the smaller banks to merge. Rising regulatory costs and technology spending needs make it very difficult for small banks to remain a stand-alone institution. At the same time, mid-size banks find it very difficult to grow in a low-growth economy. Since most of these banks are publicly traded, growth is imperative. The only way to grow is to buy. You have a pool of banks that need to sell and a pool that needs to buy. It is a perfect storm of sorts.
Many of these smaller banks came into being as a mutual thrift institution and later converted to stock ownership. This allowed them to pursue commercial deposits and loans and grow the newly public bank. It also created liquidity and increased the pool of potential buyers of the bank. There are restrictions on a sale for the first three years after the conversion is complete, and an astounding percentage of converted thrifts are sold shortly after crossing the three-year threshold. Of the 19 former thrifts that have been sold since the start of 2015, nine had converted less than five years prior and five had converted less than four years before selling.
It just makes sense each year to keep track of thrifts as they get closer to that magic three-year mark where they can be sold. This is even more true today as the converted thrifts tend to be fairly conservative institutions that have sound loan portfolios and many of them still have very high equity levels as they still have cash left from the conversion offering. This combination makes them very attractive takeover targets.
There are seven former thrifts in the 2016 class that will be eligible for a change-of-control transaction. Some of them are way too small to talk about here, but there are a couple that I think would make very attractive targets and still be a good investment even if no deal happens.
Charter Financial (CHFN) has branches in its home state of Georgia as well as in Alabama and the Florida Panhandle. It has been using capital to buy other banks as it attempts to expand into the very lucrative Atlanta metropolitan markets. Since the credit crisis, it has completed five takeovers and has a deal pending to buy CSB Financial in the north Atlanta market. The equity to assets ratio is still around 20 and it has been enthusiastic buyers of its own stock.
In the last two years, Charter Financial has reduced its total share count by almost 30%. This is a really well-run, shareholder-friendly bank that should be a profitable investment if it remains independent forever. However, once the restrictions are gone in April, the asset base and attractive branch network could make it a target. The stock trades right around book value and yields 1.47% at current prices
I have owned shares of Westbury Bancorp (WBB) for a few years simply because it was a cheap bank stock with strong financials. I had never talked to anyone at the bank and had to use a search engine to find West Bend, Wis., on a map. I met CEO Greg Remus and CFO Kirk Emerich at a conference in Phoenix last month and I walked away with warm fuzzies about my investment in their bank. These guys are community bankers in the Jimmy Stewart Bailey Savings & Loan mode. They are smart lenders as the 0.11% nonperforming asset ratio clearly demonstrates and they know their market extremely well. Returns on equity and assets have been steadily improving since the conversion. They also just announced their fifth consecutive stock buyback plan and will be repurchasing an additional 10% of the bank. The previous four programs repurchased 1,117,352 shares, shrinking the share count by more than 20%.
These are good guys running a good bank, and while I hope they remain in control for many years, they will be very attractive to potential suitors when the takeover restrictions end in mid-April. Westbury shares currently trade at just 92% of book value.
Tracking mutual thrifts and the expiration of takeover restrictions is just smart. You are buying well-financed banks that are usually priced cheaply compared to book value and there will be many larger banks that will take a look at acquiring them at higher prices.
You may recall that when mutual thrift savings institutions make the decision to go public, there is usually a one-year prohibition on dividends and buybacks and a three-year takeover restriction. Often these high-quality, capital-rich institutions receive an offer not long after the three-year period has passed. Before the financial crisis, the average life span of a converted thrift was about 5.4 years. That time period has lengthened some, as deal pace slowed during the crisis, but it looks like it is shortening again. The majority of recent former thrift takeovers had been public less than five years.
Now I want to want to visit some that passed the time limit last year and may soon attract the attention of buyers looking to grow their asset base, branch network and earnings power.
FS Bancorp (FSBW) of Mountlake Terrace, Washington, passed the three-year mark back in July. The institution just closed on a bank-branch deal with Bank of America (BAC), and now has 12 branches in the Puget Sound area, with almost $700 million in assets. The bank is in excellent financial shape, with an equity-to-assets ratio of 11.62. Its loan portfolio is also in fantastic shape, with nonperforming assets that are just 0.11% of total assets.
It just reported record earnings for 2015 and announced its 12th consecutive dividend. The stock is trading just below book value and yields 1.15% at the current price. It has a buyback plan in place that has 325,000 shares remaining, but did not buy any shares in the fourth quarter of 2015: The company needed cash for the branch deal and the stock price was generally rising. There are several bank stock specialists and activists — including Wellington, Joseph Stilwell and FJ capital — that own shares of the bank.
HomeTrust Bancshares (HTBI), with 39 locations in North Carolina, Tennessee and Virginia and $2.7 billion in assets, would appear to be a perfect target for a larger bank looking to expand in the area. The three-year mark passed back in October, and it is in some great markets. Potential buyers better be prepared to hit a moving target, as management at HomeTrust is a lot more interested in buying than selling. Since the conversion, it has used whole-bank and branch acquisitions to grow its asset base from $1.6 billion to over $2.7 billion, today. The bank has 130,461 shares left on its 5th buyback plan since conversion. The plan was announced back in July and the bank just announced a 6th repurchase plan for another 5% of outstanding shares. They are also in great financial shape with an equity-to-assets ratio of 12.04 and nonperforming assets that are just 1.19% of total assets. The stock trades right around book value, right now. FJ Capital is also is a shareholder of the bank.
Northfield Bancorp (NFBK) is another former thrift that has been doing some buying. The New Jersey-based bank is acquiring Hopewell Valley Community Bank (HWDY), and the resulting bank will have $3.6 billion of assets and a very attractive network of 18 branches in Hunterdon, Mercer, Middlesex, and Union counties, New Jersey, plus 21 branches in Staten Island and Brooklyn, New York. They have plenty of capital ,with an equity-to-assets ratio of 15.97, and nonperforming assets are just 0.50% of total assets. Management has done a very good job of managing the bank and the shares currently reflect that — trading at 1.31x book value. Even though Northfield has been eligible for takeover offers since the end of last January and has a very attractive footprint in the Northern New Jersey and New York City markets, so any potential acquirers will have to be willing to pay premium prices.
Buying thrifts that are near or beyond the takeover threshold is a smart approach to investing in the trade of the decade. Even if a takeover offer does not materialize, you are usually buying a well-run bank with plenty of capital and strong loan portfolios. If you focus on the price you pay and accumulate shares at or below book value, this approach should work out very well for you.
Before I move on from converted thrifts, I want to visit some more older conversions that have managed to hang around without being taken over. The credit crisis changed things in the banking world and some thrifts that converted during the early stages of the recovery have managed to stay off the radar screens of the more acquisitive banks.
What makes these banks so interesting to me as an investor is that they raised capital when things were bad and have been able to grow as conditions improved in the industry. Many of them are trading at levels that make them very attractive long-term stocks and they may attract a bid as the M&A wave in small banks rolls along.
From the Class of 2011, we have ASB Bancorp (ASBB). Given the amount of banks looking to expand in North Carolina, I am surprised ASB has not yet attracted a bid. I suspect it is only a matter of time, as it has a very attractive network of 13 branches and about $780 million in assets. Bank activist Lawrence Seidman owns 6.7% of the stock and recently gained a board seat for his nominee. Seidman has not been shy about what he wants the bank to do going forward.
Back in August, he sent a letter to the ASB board that said, “Unfortunately, the ASBB board and senior management have not earned the right for ASBB to remain independent due to its poor financial performance during their extended tenures. Much has been written about ‘too big to fail,’ but unfortunately ASBB falls into the category of too small to survive.”
The bank is in decent financial shape with an equity to asset ratio of 10.76 and non-performing assets that are just 1.04% of total assets. The bank has not been able to increase returns to anywhere near industry averages and would probably fare better as part of a larger institution. The shares are trading at 95% of book value, so there is decent upside to the average takeover multiple of about 1.4.
The Class of 2010 has another bank that is an outstanding candidate for a trade-of-the-decade portfolio. Eagle Bancorp (EBMT) is the holding company of First Opportunity Bank of Montana, based in Helena. The bank has 13 branches in southern Montana with about$ 625 million in total assets. It is in good shape with an equity to assets ratio of 10.36 and a non-performing assets ratio of just 0.5%.
The bank has made some small acquisitions in the past but it probably needs to pick up the pace of growth to get past the $1 billion asset level. The shares are trading at around 90% of book value and the valuation and valuable footprint could attract the attention of an acquirer. It has a buyback plan in place but has not been very aggressive as it repurchased only 15,000 shares in the fourth quarter. The bank could make its stock more attractive to acquire enough assets to go over the $1 billion mark by more aggressively buying back shares. This is a bank that needs to either grow or sell, and either of those will be good for shareholders.
Also from the thrift conversion Class of 2010 is Atlantic Coast Financial (ACFC). The bank is located in Jacksonville, Fla., and has 12 branches with $855 million in total assets. While the loan portfolio is in great shape, with non-performing assets of just 0.87%, the equity to assets ratio is a little lower than I like to see at 8.98. Florida has been red hot for community bank merger activity, and at some point this bank is going to attract the attention of a larger franchise looking to expand here in the Sunshine State. There are several potential activists in the stock, including PL Capital, FJ Capital and Wellington, that might be willing to give them a nudge in the direction of a sale. The shares are trading at 1.07x book value and Florida buyers have been paying premium prices, so there would seem to be plenty of upside in the stock at this price.
A significant percentage of the banks in my trade-of-the-decade portfolio began life as mutual thrifts. After the conversion, most of them are well-run, well-capitalized institutions that are likely to attract the attention of a buyer at some point in time. They may be off Wall Street’s radar screen, but they should be on yours.
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Originally published as 3 part series on RealMoney.com