Banks, Cyber and Black Eyed Peas

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As we head into New Year’s weekend, I find myself reading a lot of year in review and next year outlook material. I am a big fan of the overviews and outlooks but try to avoid those prognosticators making specific predictions they insist are actionable right now for the low, low cost of your retirement accounts. I find that by reading a bunch of the overviews, I can begin to develop a picture of potential developments and obstacles an industry or market my face in the New Year. I won’t act on them today but being aware of what might happen allows me to have a game plan ready if the events do unfold in the manner.

I probably spend more time on banking and real estate outlooks than anything else since that is where I focus much of my attention. Of course, I also believe that if you understand what is going on in the banking sector and real estate markets of a given city, town, nation or continent you know everything you need to know about the economy of that locale.

Deloitte, the global audit, consulting, financial advisory, risk management, and tax consulting firm released their Banking and Securities Outlook 2017 this month, and there are some key takeaways for us as investors. The company thinks that post-election may have brightened the outlook for banks and securities firms, but challenges still exist. Banks will face significant technology challenges in 2017 and will probably have to spend some money to build and protect a new model of banking in a Fintech world.

Deloitte is equally confidently caution about the overall economy saying “US gross domestic product (GDP) growth should be higher than in 2016, reflecting a tighter labor market. However, this almost-full employment is far from ideal; a serious skill divide exists alongside too many temporary and underemployed workers. The resulting low productivity growth could lead to a plateau as the year progresses.” I have been saying this for some time as the job creation I see outside the beltways and rivers is not of the kind we need to achieve higher growth rates and I still talk to a lot of people who are incredibly frustrated with their inability to find a meaningful and rewarding job. Better, not good. Perhaps now that a firm as renowned as Deloitte agrees with me, I will finally get the recognition as a brilliant economist that I clearly deserve!

The company also addresses one of my favorite topics, Bank M&A. The report notes that “M&A activity may slow considerably until greater clarity about the coming regulatory landscape emerges, possibly prompting a fundamental rethink of business strategy. Even so, large national banks will likely continue strategic divestitures to hone their business footprint, shedding ancillary businesses that aren’t core to the portfolio of client services and don’t generate sufficient ROI. Large regional banks with assets in excess of $50 billion may continue making strategic acquisitions to better tackle regulatory compliance overhead. Smaller regional banks approaching $50 billion in assets will try to get comfortably above that mark to attain operational and compliance heft that systemically important financial institutions require. However, most M&A activity will take place among banks with assets between $1 billion and $10 billion. “Since we primarily live in the under $10 billion world we are okay with this.

I spoke with Chris Marinac of FIG Partners also had some comments on M& in community banks when I talked with him earlier this week. When I asked him if M&A was coming to an end or was still a secular trend he told me “I think it’s definitely a secular trend. I think M&A is here to stay. I think if anything, M&A accelerates because of higher prices. Currencies really drive M&A. What happens over time is that stock prices tend to have wider dispersion regarding their evaluations. That is beginning to develop, and I think it will continue to occur as 2017 unfolds, and what that means is that there’s a bigger spread on the price-to-tangible-book, and as that happens, the buyers distinguish themselves from the sellers, and more transactions can happen.

“There are still many boards of directors who I would say are tired by the environment. They certainly were scared by what went on during the financial crisis years, and they remember what it felt like. And when they’re given an opportunity to come out at a reasonable price, and particularly when they can take strong currencies from the buyer, I think there are enough banks who will say yes and take that on. I think the decision was made a long time ago that they would like to sell. It was just a question of when they could get a reasonable price. This is still an ego game, and the egos don’t like when they have to take a low price, and something that is seen to be less than a real market bid. Now that pricing has come back, I think egos can very much be massaged into feeling good about a particular M&A transaction, and if the pricing is much better.”

“So I still think the number of M&A deals will be higher at ’17 versus ’16 and ’15, and I think that there are going to be some banks who decide not to sell because they feel a little bit less pressure from the regulations. But honestly, I think there are enough boards who want to get a transaction done because the pricing is better, and that they can get a price that they can be happy with and feel good about. That’s where I think the ego comment is important because I think this is an exercise in human behavior as much as it is finance.”

Both Deloitte and Chris had some comments on cyber security as well. The Deloitte report said that “While core cybersecurity threats remain the same, more sophisticated threat vectors are emerging resulting in greater impact. For example, in addition to distributed denial-of-service (DDoS) attacks, denial-of-system attacks that make enterprise-wide information systems completely inoperable are likely to increase. With cloud adoption accelerating, encryption, identity, and access management are likely to dominate the agenda. Also, regulatory pressure is likely to increase, forcing banks to focus more on regulatory compliance rather than risk mitigation.”

Chris Marinac was in agreement telling me that “the concept of cyber security in the regulatory framework is awfully important. In fact, I would say that cyber might drive certain companies out of business, because the regulators are as serious as a heart attack about banks and boards of directors being all in on cyber. That’s in spending, and it’s also just an attitude commitment that you have to be vigilant 24/7 on cyber security, and you have to be on guard, and if you’re not, that’s going to create regulatory decimation where there’s going to be some of the companies who just can’t take it, and they have to move on. So I feel like the cyber, and the tech spending is still a real topic, and that if anything, companies might be investing savings that they’re getting on taxes. If we get tax reform, or frankly better spreads, which I think are going to happen, you might see companies taking the revenue from a better margin, and perhaps stronger net income because of taxes, and reinvesting some of those profits back into technology spending to not only make sure that they’re in line with the rest of the Jones’ but also that they’re ahead, that they can anticipate the problems. The cyber issues, large and small are still out there. “

Write this down. If we did a remake of Mrs. Robinson today, Mr. McGuire’s one word would be “Cyber.” All the great new things that technologists and pundits see happening are heavily reliant on cyber security. FinTech, EdTech, robotics, driverless cars, virtual reality, the list goes on and on, and every single one of them is hackable and will require a constant and expensive vigilance on cyber security. You need to be aware of the best companies and emerging technologies in cyber security because lacking an EMP blast that takes us back to the stone ages Cyber Security is the going to happen 100 to 1 sector right now. Be patient, buy at a good price but be aware of what is going on in the sector and who is doing it.

Happy Year to you all and best wishes for a happy, safe and prosperous 2017. Will be kicking back at home this year as over the years I have had one too many drinks spilled on my suit, one too many overindulgers puking on my shoes and paid way too much money for high priced poorly prepared “special “ dinners that weren’t. We will break out the bourbon, some good wine and spend a nice, safe evening watching those foolish enough to flock to Times Squarer freeze their butts off and most likely pee their pants to welcome 2017. Of course for New Year’s day we will cook up the pork roast and black eyed peas to greet the year. I am not particularly superstitious, but I do like a tasty tradition.

Flawless Predictions

Originally published on Real Money December 23rd 2016 at Real Money

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Originally published on Real Money.com December 23 2016

oday we kick the holiday into high gear around our house. We have a party for Christmas Eve every year, and of course, there is a huge dinner to cook for Sunday, so there is lots of shopping and prep work that begins today. There will be last-minute errands, packages I forgot to wrap and late additions to the bar I need to pick up. It will be a busy few days, but if history is any guide, it will be a good time for all.

The other thing that has kicked into high gear is the prediction machine. I am getting a flood of emails offering to tell me exactly what the market is going to do in 2017. Some are pie in the sky, and some are doom and gloom.

So far, the range is from up 30% to down 70% for the S&P 500 next year. We could have runaway inflation or a disastrous return to severe deflation according to the experts. Oil is either going to $100 a barrel or collapsing to $10 depending which expert you choose to believe. Real estate is probably going to collapse unless it soars as a result of inflation. Interest rates will spike unless they collapse.

The predictions range from very well considered and presented analysis of the possibilities in 2017 to just plain wild-eyed rants. The former are generally from the big Wall Street and mutual fund firms, and the major goal of these pieces seems to be to keep investors in the fold with their cash continuing to earn fees for the company. The general outlook is for decent gains with positive economic activity and the possibility of some increase in what they call volatility. They are as much marketing pieces as anything else.

The latter are marketing ploys. If you make a prediction of epic proportions and it comes anywhere close to coming true, you will be a temporary legend. In spite of all the evidence that such predictions are nothing more than lucky guesses, the suddenly wise prognosticator will be showered with attention and cash from the investing public. It begins to taper off in a year or so when the role of luck becomes more apparent as subsequent forecasts fail to hit the mark, but the lucky fortune teller does not need to return the cash. More than one decent fortune has been made using this technique, so as long as you have little to no conscience, it’s a sensible ploy.

That said, this prediction thing seems like fun, so I think I will get in on the action. I have been making forecasts for a couple decades now, and I humbly can say that I have the best market and economic forecasting track record in history, and I think it is time you folks starting rewarding me with accolades and cash.

In 2017 the stock market will be open most weekdays between 9:30 a.m. and 4:00 p.m. ET. Prices will fluctuate, sometimes wildly. At least one company everyone loves will collapse at some point during the year. At least one company no one has ever heard of will soar to uncharted heights and become a stock market darling in its own right for a period. Millions of lines will be drawn on millions of charts, with no real useful conclusion being drawn from such activity. There will be unanticipated geopolitical situations that roil the markets at some point during 2017. Pundits will predict all sorts of outcomes. Some will be right, most will not. If the world does end before then, NYSE traders will stop what they are doing on the last trading day of 2017 and sing “Wait Till the Sun Shines, Nellie.”

My forecast is far more likely to be correct than most in 2017, thereby extending my record of flawless punditry, and it has about the same chance of making you money during the New Year as all the others. As for me, there are a few macro pieces I read every year and consider, such as the KKR macro outlook and the outlook pieces from large commercial real estate brokers, but these tend to be more informational than predictive in nature.

Make 2017 the year you begin to react to what the market does rather than trying to predict what it might do. I predict you will make more money that way.

Ignoring Warren and Charlie

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Originally published on May 2 2016 on Real Money

There will be a few jillion words written on Berkshire Hathaway’s (BRK.B) annual meeting but I am going to add my two cents anyway. After watching some of the live-stream broadcast and reading several commentaries, I came away with several strong impressions.

The first impression is one I get every year after the meeting. There are far too many people running around trying to be Warren Buffett and invest like Warren. You and I will never have the advantage he has enjoyed of free leverage in the form of insurance float, and odds are we will never get the phone calls for special convertible deals on companies such as Bank of America (BAC) and Goldman Sachs (GS) at incredibly advantageous terms.

Buffett has said many times that he is limited in what he can buy because of the sheer size of Berkshire. On Saturday he pointed out that size is the enemy of performance. He has admitted repeatedly that returns would be higher and that Berkshire would do more Graham-like investments if it had a smaller asset size. Even Vice Chairman Charlie Munger has said that would be his approach if he had smaller capital.

Investor Monish Pabrai wrote about his discussion on this subject with Munger last year at the Huntington Library saying, “I asked Charlie if he would still promote the buy and hold forever notion if he were running a small pool of capital. He said that he’d do it like he did when he ran his partnership, buy at a discount, sell at full price and then go back. With their present situation he said that it makes no sense to do that.”

Despite the above, too many investors are trying to emulate Buffett by buying huge companies with ever-elusive moats that they can hold forever and a day. What is worse is they do it without looking at where we are in the market and are quick to quote Buffett about ignoring day-to-day market prices. While that may be good advice in general, you need to go back and study when Buffett bought his biggest positions.

He started buying the Washington Post in the 1973 stock market collapse. He began building his Coca-Cola (KO) stake after the crash of 1987. His Bank of America and Goldman stakes came in the aftermath of the credit crisis. The big initial buys of Wells Fargo (WFC) were done during the banking and Savings & Loan panic in 1990.

Buffett may not worry about the quote and market conditions after he buys a stock but he is very aware of conditions when he is buying. Both he and Munger are crash buyers in the spirt of Hetty Green and Mr. Womack, which is the real secret of their success. Want to be like Warren? Stockpile cash between crashes and buy stocks during a panic.

If you are buying stocks, Buffett reiterated his suggestion that you should view it as buying the whole business — and you should be comfortable with being unable to get a quote for the next five years. This is probably one of his most ignored pieces of investment wisdom. Investors are far too concerned about liquidity and I believe they often overpay for liquidity.

We know from the Ibbotson studies that illiquid stocks with value characteristics provide the highest returns over time. Still, if you talk to most investors, they own very liquid shares of companies with growth characteristics and higher valuations. These are, of course, the stocks with the lowest long-term returns. If liquidity is a primary concern, you probably should not own stocks.

I hear the liquidity argument all the time when talking about investing in community banks. These little banks can be hard to buy and harder to sell. It can take weeks — even months — to buy a full position in some of them. That scares away many investors from what has easily been the most profitable part of my investment activities for decades now. Now is probably the best environment for buying community banks since the early 1990s, but most investors will miss it because of their ill-advised concerns about liquidity.

I will leave it others to discuss Buffett’s comments on sugar consumption, diversity, hedge funds and politics. The big takeaway for me is since I am not dealing with the issues of a $350 billion enterprise I should be thinking about smaller, less-liquid stocks and focusing on when I buy and what I pay for stocks. I can ignore market gyrations after I own them but they are pretty important when it comes to buying.

Right now, aggressively buying socks when the market is trading at 22x declining earnings strikes me as one of those “stupid games” Buffett was talking about Saturday.

The ABA on Dodd-Frank and Community Banks

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Below is the ABA’s answer to the White House Council on Economic Advisors​ suggestion that community banks had no problems with Dodd-Fran Legislation and were better off becaue the bill passed.
It also outlines the reason that bank consolidation will continue and you need to be a member of Banking on Profits. We have al sot fille dall our slots and will be closing the serice to new members very shortly. Click Here to lock in 50% off for the life of your membership and get teh Monthly Communiyt Banks Stock Investor free with your membership. Use coupon code 50OffBoP​.
August 24, 2016

The Honorable Jason Furman President’s Council of Economic Advisors

Eisenhower Executive Office Building Room 360

1650 Pennsylvania Ave

Washington, DC 20504

Dear Dr. Furman:

First, I appreciate the work of the Council to document the consolidation of the banking industry in your recent report entitled “The Performance of Community Banks Over Time.” This report is long overdue as community banks have been urging the Administration, Congress and regulators to address the rapid decline in the industry. Having thoroughly reviewed the report I must admit to being baffled by your findings. You are correct that community banks are resilient and have endeavored to provide the vital financial services critical to the success of their communities. It is also true that consolidation is not a new phenomenon affecting the banking industry. But the notion that the Dodd-Frank Act—and its 24,000 pages of proposed and final rules—has had no impact on community banks is simply untrue.

The report concludes that the decline in the number of banks since Dodd-Frank was enacted—1,708 or 22% of the industry—is not compelling evidence that the Act has had a negative impact. As proof that somehow the loss of a bank every business day since DFA doesn’t matter, the report states that bank branching patterns, lending growth and geographic reach “show that community banks remain strong.”

A conversation with any community banker would dispel this forced conclusion. The thousands of new regulations that have been imposed on community banks is an enormous driver of decisions to sell to a larger bank. The median sized bank in this country has only 42 employees. These are small businesses themselves. There is simply not enough capacity to read and understand what rules apply (especially as rules are modified); implement, train, and test for compliance with those that do; and still have the time and resources to meet with individuals and businesses about their financial needs. According to research by the American Action Forum, “it would take 36,950 employees working full-time (2,000 hours annually) to complete a single year of the law’s paperwork.”

Some banks have stopped offering certain products altogether, such as mortgage and other consumer loans. The October 2015 RESPA/TILA integration rules have raised mortgage costs, delayed closings and have limited access to home loans to many potential new buyers. TRID Survey Results In April 2016, 72 percent of community banks reported that the 2014 rules on ability to repay and qualified mortgages have restricted their ability to extend credit, even after over two years of adjustment and adaptation. Mortgage Survey Results

Moreover, the rules intended for the largest banks are too often considered ‘best practices’ for all banks, compounding the hardship for smaller institutions. Arbitrary size thresholds create disincentives for community banks to grow because of the significant regulation that is added as soon as the threshold is crossed. This limits the services they could provide because of arbitrary rules, not business decisions to meet community needs.

Even more troubling is that strong, well-run community banks are telling the ABA that they have no choice but to sell. Just a few weeks ago, a banker in the Northeast wrote to us and said:

“Unfortunately we became a victim of Dodd-Frank. The effects of Dodd-Frank, including the TILA-RESPA integration, the pending expansion of HMDA, ability to repay, forced-placed hazard insurance requirements, plus other regulatory issues such as the pending overdrafts rules, restrictions on small dollar lending, the military lending rule, the Durbin Amendment, etc… resulted in financial projections showing substantial declines in revenues and increases in compliance costs, reaching the point that in a few short years an otherwise healthy community bank with strong capital and satisfactory earnings could no longer meet a number of financial bench-marks set by the regulators. These conclusions forced the bank to sell now when our shareholders and some of our employees would be less adversely affected.”

In May this bank merged with a much larger bank, resulting in approximately 50% of the employees losing their jobs, all because of the cumulative impact of regulation. Sadly, this is not an isolated case. The Council’s report documents very carefully the fact that community banks are exiting, primarily merging with other community banks. The report shows the decline quite dramatically, particularly among the smallest banks. Does it matter if small banks are merging? The CEA concludes it does not since community banks “remain strong.”

What happens when this trend continues—as it surely will—if nothing is done to stem it? Community bankers are community leaders. They are involved in many local organizations, serve on school and hospital boards, donate thousands of volunteer hours to charities—all in addition to the advice they provide to small businesses, families and individuals, young and old, about their daily financial and banking needs. If this trend continues unabated, there will be fewer financial services in communities and less economic growth. Whether intended or not, the Dodd-Frank Act has added fuel to industry consolidation, reduced flexibility for product offerings, and increased the cost of providing financial services—a cost that is ultimately is borne by customers.

The report also suggests that the increased pace in consolidation since 2010 is due to the lack of de novo banks, not a change in “exit dynamics.” It argues that the lack of de novos is a result of low interest rates. The exceptionally low interest rate environment certainly has had a negative impact on all banks and no doubt has had a role in limiting new bank charters. But new banks have been formed in large numbers through many recessionary times. For example, in 1990—the middle of the so-called “S&L Crisis” and the beginning of a recession—there were 193 new banks chartered. Over the next 10 years, 1,500 new banks were chartered.

Contrast that with the latest cycle: it started similarly with 181 new charters in 2007 (the start of the recession) but fell off very quickly over the next two years. Since the Dodd-Frank Act was enacted in 2010, there have only been 7 de novos with three of those started only to facilitate an acquisition of a failed bank and another for a credit union to convert to a bank. That means only 3 real new banks in the last 5 years. Even more telling is the contrast between the lack of de novo bank formations and the recovery of new business formations across all industries since the recession.

Sadly, the forces that have acted to stop new bank charters are the same ones that have led to the dramatic consolidation of the banking industry—excessive, and complex regulations that are not tailored to the risks of specific institutions. Beyond Dodd-Frank, there are new capital hurdles, unreasonable regulatory expectations on directors, funding constraints, an inflexible regulatory infrastructure, and tax-favored competition from credit unions and the Farm Credit System that weigh on community banks. These—not the local economic conditions—are often the tipping point that drives small banks to merge with banks typically many times larger and is a barrier to entry for new banks.

The question that the CEA should be asking is how prudent regulatory relief will contribute to economic growth. Stemming the tide of consolidation in the industry will help preserve the unique banking system that has led to the strongest economic country in the world. If we continue to watch the industry shrink by one bank every business day, the availability of financial services will decline, particularly in the thousands of smaller communities where the bank is the only financial institution serving the area.

Each and every bank in this country helps fuel the U.S. economy. Each has a direct impact on job creation, economic growth and prosperity. Community banks have always prided themselves on being flexible in order to meet the unique circumstances of each customer. These institutions are working hard to drive economic activity in America’s cities and hometowns, but the regulatory environment is holding them back.

Comprehensive regulatory relief is long overdue for community banks. This is why it is imperative that the Administration and Congress take steps to ensure and enhance the banking industry’s capacity to serve their customers, thereby facilitating job creation and economic growth. And each day another community bank leaves the field, it makes that community—and our economy—poorer.

Banking on Business

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Originally published as a series on Rel Money

CNBC’s annual “Top States for Business” list came out this week, and it occurred to me that if a state is a great place for business, then it’s probably also a fantastic place for banks. So, let’s use my next two columns to look at promising bank stocks in the five highest-ranked states — Utah, Texas, Colorado, Minnesota and North Carolina.

I’ll look today at some good publicly traded banks in Utah, Texas and Colorado, and use a future column to run down promising financial firms in Minnesota and North Carolina.

Utah only has two publicly traded banks, and I like Peoples Utah Bancorp (PUB) , which is based in the booming community of American Fork.

PUB has 19 branches around the state and about $1.5 billion in assets. It’s a well-run little bank, with a better-than-average efficiency ratio of 0.56 and an above-average return on assets of 1.44%. The firm’s loan portfolio also skews heavily towards industrial and commercial-real-estate loans, which is a big plus for a bank that’s located the country’s most business-friendly state.

Unfortunately, PUB isn’t cheap at a 1.48x current book value. But if you value earnings, the stock’s P/E ratio is just 15. That’s eminently reasonable for a well-run, high-growth community bank.

Now, I’m not personally capable of chasing a stock higher. But PUB could make a strong addition to my long-term portfolio the next time the bank’s stock price pulls back.

Picking a good Texas bank to invest in is easy, as I’m a big fan of Green Bancorp (GNBC) , which I’ve already been buying over the past month.

GNBC operates in the major Texas metro areas of Houston, Dallas and Austin, but has recently exited energy lending and is disposing of all energy-related loans. In their place, the bank’s portfolio heavily favors commercial real estate and commercial and industrial loans. This should be a huge positive for the firm.

CEO Manny Mehos founded, expanded and sold a different bank in the past, creating outsized gains for his shareholders — and I expect this scenario will eventually play out again at Green Bancorp. Private-equity investors own a little more than 13% of GNBC’s shares, and they probably have their eye on a future sale of the bank as well.

There’s only a very small handful of publicly traded banks in the Centennial State, and National Bank Holdings (NBHC) is my pick.

The bank has 99 branches and some $4.6 billion in assets, with 1.73% of that considered nonperforming. NBHC has also done a smart job of growing by acquisition, and has also been aggressive with stock buybacks. Since 2013, the firm has repurchased 45% of its shares outstanding at a $19.87 weighted average price (the stock currently trades at around $21).

Commercial-real-estate and and commercial/industrial loans make up about 50% of the firm’s loan portfolio, while single-family mortgages account for another 22%. That’s good news in a state that CNBC’s study found had America’s No. 1 workforce.

Another potential plus for Colorado banks is the state’s legalization of marijuana sales, which currently contradicts federal law. Colorado’s legal pot shops generally can’t use the traditional banking system right now, but I believe that will change if and when the U.S. government inevitably takes marijuana off the federal illegal-drug list.

Colorado retailers legally sold almost $1 billion of marijuana last year, and that doesn’t even include smoking supplies and accessories. The second that the federal government legalizes their business, banks will want to serve the industry — and I expect a bit of a “gold rush” to get into the state’s banking market.

National Bank Holdings would make a perfect target for a larger regional bank that’s looking to move into the state. The bank currently trades at a modest 1.15x book value, but any transaction would undoubtedly occur at a much higher multiple.

On the downside, NBHC does have about $132 million of energy exposure on its books. It also earns just a 0.14% return on assets — much lower than its peer-group average of 1.03%.

It just makes sense that if a state is a good place to be in business, it’s a good place to own a bank. Choices were limited in Utah and Colorado as there simply are not that many publicly traded banks, but we came up with one in each state that should be an outstanding long-term holding. There were a lot more choices in Texas, but most of them are trading at premiums and many have a high level of exposure to the oil and gas industry. I picked my most recent bank purchase, Green Bancorp (GNBC) , as it has eliminated its energy exposure and the stock trades below book value. Today I want to look for banks in the two remaining top five states for business.

I never really thought of Minnesota as a big pro-business state, but not only is it fourth this year in the CNBC report, but it ranks seventh over the last decade. The state scores high for infrastructure, education, technology and quality of life, and the combination has kept it in the top tier of the ranking. There are not a lot of publicly traded banks in Minnesota, but there are two banks worth considering for your long-term portfolio.

TCF Financial (TCB) is a bank with $21 billion in assets and a strong, diversified loan portfolio. In addition to traditional consumer and commercial portfolios, TCB has divisions that do auto lending, inventory financing and equipment leasing. These are higher-yielding businesses and TCB does a fantastic job of underwriting the loans as its nonperforming assets are just .14% of total assets. The bank has 399 branches across the Midwest and conducts its financing operation all over the United States. The bank trades at about 120% of tangible book value but is cheap when valued on earnings, with a price/earnings ratio of just 11. The stock pays a 2.34% yield, so you do collect some income while waiting for the favorable business climate to help lift the shares over time.

North Carolina does come to mind when I think of business-friendly states. The state has strong financial, agricultural and manufacturing sectors and the presence of major universities in the research triangle of Raleigh, Durham and Chapel Hill has spurred growth in biotechnology and high-tech industries. Here we have a lot more choices to consider.

I am a big fan of Asheville, North Carolina-based HomeTrust Bancshares (HTBI) . The bank has been in growth mode since completing its conversion from a mutual thrift to a shareholder-owned bank. Since then, HomeTrust has added five markets and grown assets from $1.6 billion to more than $2.7 billion. It also has been active buying back stock and has repurchased about 25% of its shares outstanding since it was allowed to begin buybacks in 2013.

HomeTrust management is focused on growing the bank in its home market of North Carolina as well as in eastern Tennessee, South Carolina and Virginia. The stock is trading at book value and is in solid financial condition, with an equity-to-assets ratio of 11.77 and nonperforming assets that are just 1.08% of total assets. HomeTrust either is going to continue to grow and drive earnings and its stock price higher or someone is going to decide it is too attractive of a franchise and make an offer for it. Either would be a huge win for investors.

Also based in Asheville is ASB Bancorp (ASBB) . This bank has been under fire from activists, and one noted bank activist, Lawrence Seidman, currently has a representative on the board. The stock is trading at tangible book value and I would not be shocked to see the bank sold at a decent premium to a larger competitor. ASB has about $786 million in assets and is in good financial shape, with an equity-to-assets ratio of more than 11 and nonperforming assets that are just 1% of total assets. The loan portfolio is a nice mix of residential real estate and commercial real estate loans with limited exposure to commercial and industrial loans or construction loans.

After last week’s madness, it was nice to have a quiet weekend before the great rebuild begins this week. A Dumpster is being dropped off this morning and I am looking forward to lots of noise and clutter.

It was not a quiet weekend in the news with failed coups, police shootings and vice-presidential madness dominating the airwaves. For a political junkie like me, the GOP convention is going to be high theater and I expect lots of low comedy as well before the week is over. With all the madness swirling around this week, I am just going to keep my head down as the week starts and look for more banks to buy in the nation’s most business-friendly states.

Washington comes in as the sixth most business friendly state, thanks in large part to high scores for technology and innovation as well as a strong economy and easy access to capital. It has been a long time since I was out in Washington, but I do have some great friends out there and have become a fan of the Gonzaga basketball team as a result. I also own a few banks based in the state that should continue to benefit from the business-friendly atmosphere.

First Northwest Bancorp (FNWB) operates 10 branches with just shy of $1 billion in assets in northern Washington. First Federal underwent its conversion from a mutual thrift to a stockholder-owned institution in January 2015 and has been a favorite holding since the offering was completed. It still has most of the cash and the equity to assets ratio is over 13. Nonperforming assets are just 0.4% of total assets, so the loan portfolio is in solid condition. The bank services the north Olympic Peninsula region of Washington and is the only community bank headquartered in the region. The loan portfolio is heavily tilted toward residential loans but it does have a decent amount of commercial real estate and multifamily loans on the books as well.

First Northwest has a shareholder list that looks a lot like a bank investors hall of fame. PL Capital, Joseph Stilwell, EJF Capital, Michael Price, Seizert Capital and Wellington all have a position in the bank’s shares. That could eventually lead to some pressure to deploy capital to benefit shareholders by buying back additional stock or initiating a dividend payout. Either would be fantastic for us as long-term shareholders of the bank. The stock is trading at just 90% of tangible book value, so it’s a great buy for patient investors at the current price.

I also own Anchor Bancorp (ANCB) in southern Washington state. This bank has 20 branches and a little over $400 million in assets. It is also in great financial shape with an equity to assets ratio of almost 14 and nonperforming assets that are just 0.73% of total assets. The loan portfolio is tilted toward commercial real estate and multifamily housing and about 20% of it is in single-family housing to residents of the business-friendly region. The stock trades at 96% of book value, so it is cheap at the current price.

At least one investor thinks the stock is too cheap. Activist Stilwell owns 9.8% of the bank and thinks it should be sold to maximize shareholder value. In a 13d filed last week, he revealed his latest letter to the board. He wrote: “This letter serves to formalize our June 15 meeting and to re-emphasize our belief that Anchor should be sold. When we met with you two years ago, your plans to work diligently and improve bank operations sounded reasonable to us. We believed you when you promised you were making sincere efforts to position Anchor to maximize shareholder value. We understand that you have done your very best. However, continued poor performance highlights the reality that Anchor should now be sold. At our June meeting, your statements on further improvement to Anchor’s return on equity by the end of 2018 sounded unrealistic to us. In our view, it is not in shareholders’ best interests for management and the board to work 2½ more years toward a marginally better, but still inadequate, ROE. Now is the time for Anchor to find a suitable merger partner.”

Stilwell has had a great deal of success over the years in pushing back into a sale, so I will not be surprised to see Anchor Bancorp announce a merger in the months ahead. A deal could be worth something on the order of $33-$35 a share based on recent deal multiples.

let’s look at interesting banks in Georgia, which came in eighth place on CNBC’s list.

The Peach State has a vibrant economy and has recovered nicely from the credit crunch’s messy aftermath. Financial services have boomed in Atlanta, and the state has a strong defense-and-aerospace industry as well.

Agriculture likewise remains strong, with thriving production of soybeans, peanuts, cotton, blueberries and broiler chickens. All told, the state got great scores from CNBC for infrastructure and workforce quality, but the network found that Georgia could do a little better on education and quality of life.

As for banks, Georgia hosts some of the better growth names, like Ameris Bancorp (ABCB) , United Community Bancorp (UCBA) and a bunch of little banks that look vulnerable to takeover offers. But to me, there’s really only one Georgia bank to consider: Charter Financial (CHFN) .

Charter has been a favorite pick of mine for some time now, and I’m excited about the bank’s future and its current stock price.

Charter is what I call a “bubble bank.” Its recent purchase of CBS Financial means that CHFN now has $1.4 billion in total assets, passing the magic $1 billion mark. The firm now also has a total of 19 branches in west-central Georgia, east-central Alabama and the Florida Gulf Coast.

Charter is committed to using both M&A and opportunistic organic growth to expand into the strong Metropolitan Atlanta region. For example, the bank plans to open a new location in Atlanta’s upscale Buckhead area later this summer.

CHFN has also done a great job of transforming its loan book from that of a thrift to a commercial bank since the firm completed its conversion from a mutual thrift to a stockholder-owned institution.

For example, the firm has done well increasing commercial exposure. Commercial-real-estate loans currently make up about 40% of CHFN’s total portfolio, with residential real estate accounting for about 29%.

Charter has also been on a buyback binge since 2014, purchasing a little more than 35% of its shares outstanding. However, that’s going to slow because CHFN shares are currently trading at about 1.05x tangible book value.

CEO Robert Johnson recently told shareholders: “We are pleased with the results of our stock repurchases over the past 10 quarters, but with our stock consistently trading above book value, we intend to focus our efforts on enhancing shareholder value through leveraging our expense structure, improving our noninterest income and realizing the anticipated growth in earnings as a result of our recent and pending Atlanta expansion.”

If management can execute its growth plans, Charter should maintain a double-digit rate of book-value growth that will drive the stock price higher. Shares could also trade at a higher multiple if the bank can maintain or grow its current 1x return on assets.

However, we can’t rule out Charter catching the eye of a larger bank that wants to expand into the bank’s growing, business-friendly region. I think any takeover would have to price the bank at 1.4x book value to succeed. That’s around $19 a share vs. CHFN’s current price of around $13.

Either outcome — a buyout or continued organic growth — should be good news for shareholders. I think you can buy the stock at current levels and add to your stake if the market is kind enough to give us a sell-off.

Owning banks in business-friendly states is just common sense. Locations where businesses can thrive have low unemployment rates and lots of people buying homes and cars. There will be stable deposit bases and good loan demand. Commercial and residential real estate markets will be strong. When we can find reasonably priced banks in these areas, long-term ownership should be very rewarding.

Note that I am planning to close Banking in Profts ot new member soon. You do have to act now to join. Because we deal with a lot of smaller stocks we have decided to limit the number of members to make it easier for all of our member to buy these little banks and share in the outsized profits. We are going to accept 38 new members and then close this product to addional members.

Those that join now will get 50% off the usual price as I want to get this done and closed so I can focus on picking stocks and not marketing. That’s 50% off for the life of your subscription not just the first year. You also get the monthly Community Bank Stock Investor every month free with your Banking on Profits membership.

The money will be made in community bank stocks as M&A picks up. The only question for you is are you going to join us on this profit rich adventure in community bank stocks? Click here to join Banking on Profits at 50% off for life and a free subscription to The Community Bank Stock Investor. Use coupon code 50OffBoP.

I look forward to a long and profitable relationship!

Adult Swim Continues

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Last month KKR & Co. (KKR) celebrated its 40th year of existence. In that time the firm has grown from a three-way partnership of Henry Kravis, George Roberts and Jerome Kohlberg with $120,000 of total capital to a private equity and alternative asset management behemoth with over $120 billion in assets.

Bloomberg recently had an excellent interview with Henry Kravis and looked back over the past 40 years. In the interview, Kravis said that over the years the firm made some mistakes by not paying any attention to macro developments.

While valuation is still the overriding factor when KKR makes an investment, Kravis believes the firm needed to be aware of the macro situation, too. “About five years ago we set up a macro asset and allocation group, which has been invaluable and made a huge difference in how we think,” Kravis said.

This can help us frame how we think as well.

Henry H. McVey is the Head of Global Macro & Asset Allocation for KKR and his outlook is regularly published on the firm’s website. Back in January we looked at KKR’s forecast for 2016 and it was pretty accurate predicting slower global GDP growth, so I was anxious to read the firm’s recently released report, Adult Swim Only: 2016 Mid-year Update.

KKR remains cautious saying, “At the risk of being labeled Master of the Obvious, today’s macro backdrop, which includes high P/E ratios on stocks and low yields on bonds, appears an extremely challenging one for investors looking for outsized returns in public markets.”

The firm doesn’t see much potential ahead for returns in the stock market. McVey notes P/E ratios are very high, and that the broader market’s ratio has increased 51% since the market bottom in 2009. He is also not upbeat about the potential for earnings growth and suggests we may see multiples contract on stagnant earnings.

The report observes that valuation measures such as P/E, price-to-EBITDA and price-to-sales are in the 90th percentile of their historical ranges and the market is fully, if not over valued at current levels.

Streaks of seven or more years of positive S&P 500 returns are extremely rare and we are probably overdue for a bad year in stocks, according to McVey.

KKR continues to favor credit over equity in the current environment. “Within Liquid Credit, we generally favor Levered Loans over High Yield, though we acknowledge one must be flexible in the current environment of heightened volatility. We also like the flexibility we have through our new five percent position in Actively Managed Opportunistic Credit to pursue periodic dislocations and/or niche areas that might be overlooked by traditional benchmark seeking mandates.”

This bodes well for business development companies and levered loan closed-end funds in the second half of the year. It also makes Blackstone/GSO Strategic Credit Fund (BGB), long a favorite of Real Money Pro’s Doug Kass, a solid choice.

KKR likes real estate assets with the potential for yield and growth, especially non-core assets with the potential for improvements. It favors those situations with a flexible capital structure as well. As individual investors, we can capture those types of situations with Apollo Commercial Real Estate Finance (ARI), Colony Capital (CLNY) and Brookfield Property Partners (BPY).

McVey does not expect to see a major global correctional as much as a period of low returns. He looks for the economy to muddle along until late 2017, early 2018 when he expects a mild global recession. The biggest market risk right now, according to McVey, comes from the potential for excessive debt creation in Europe or China as well as “mounting geopolitical risks.” He notes that we are seeing unprecedented “splintering of political harmony” around the world, which presents some risk to the global economy and markets.

As you can tell, this is not an upbeat outlook. McVey believes simplicity is overvalued right now and that remaining opportunities lie in complex and idiosyncratic situations. He thinks that, barring any shock, the global economy will just continue along at a very slow pace, which is very much in line with my “better, not good” outlook on the economy.

McVey suggests that more volatility is likely in the future and that public market valuations are full and returns on capital have probably peaked.

In his conclusion McVey writes “…Are we being too cautious? We do not think so; some selectivity seems required after 84 months of economic expansion amidst rising geopolitical tensions. Maybe more, though, is our view that the investment community now better understands that lower rates and more stimulus suggest slowing nominal growth and low returns now lie ahead.”

KKR is one of the most successful investment and private equity firms in history. It has a very cautious view of the world right now and investors would be wise to follow their lead in these turbulent times.

Banking Done Right

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Originally Published on RealMoney.com

As I was doing my “ready for the weekend pizza and vino” run last Friday, I got a ring and checked my phone to find a very interesting email. John Allison, CEO of Home Bancorp (HOMB), let me know that he thought I was unfair to his company when I suggested the stock was too rich to buy at current levels. He is the founder and largest shareholder of the bank and he reminded me that it has been the fastest-growing community bank since 1996. Allison is one of the best bankers on the planet if you measure his performance by return on assets, efficiency ratio and growth rates, so I agreed to talk to him the next day and hear his side of the story.

It’s a really good story. Allison got his start in banking when he was appointed to the board of a small local bank, First National Bank of Conway, in the 1980s. Shortly after joining the board, he teamed up with some fellow shareholders and bought the bank and was named chairman. A few weeks later, the bank got a memorandum of understanding from Federal Deposit Insurance Corp. (FDIC) regulators for poor policies and credit issues. He told me that he rolled up his sleeves and dove in head-first to fix the issues and it was the best thing that ever happened to him. He learned the ins and outs of the banking business in the process, and the rest, as they say, is history. In 1985 the bank was sold to First Commercial at a decent profit and he joined the board at the new bank.

While at the First Commercial, he led a team that worked to buy Texas banks and assets during the late 1980s oil bust. They were very successful in working with the Resolution Trust Corporation to do profitable deals and they grew the bank by hundreds of millions of dollars. First Commercial eventually was sold to Regions Bank in 1998 for a staggering 4.11x book value. Later that year he joined with Robert H. “Bunny” Adcock, Jr., to buy a bank in the booming metropolis of Holly Grove, Arkansas, that had about $25 million in assets. They moved the charter to Conway, Arkansas, and today the bank now known has Home Bancorp is a $9.6 billion banking organization.

Mr. Allison explained the process to me. He said he was not looking to buy healthy banks as they expanded. They wanted to buy broken or poorly performing banks and fix them. The opportunity to make big money, he said, was in buying bank with a 0.5 return on assets and getting it up to a 1.5% or 1.75% ROA. He will not and has never done a dilutive deal. If a deal does not have the potential to significantly move his earnings-per-share needle, he simply won’t do it. If the target bank won’t do the deal on his terms, he moves onto the next one. He is openly scornful of banks that do dilutive deals and overpay for target banks.

As we talked it occurred to me that John Allison and I were doing he exact same thing with community banks. We are looking for underperforming banks that really need to sell and then invest in them in hopes of a high rate of return. I am looking to get there first and then hopefully sell them to Allison and other acquisitive bankers, but out approach is basically the same.

Then he said something eye-opening. Allison said as banks move up to and over the $5-billion asset mark, the price-to-earnings ratio and EPS growth rates are far more important than price to tangible book value. I can tell you that I really wish he hadn’t said that because John Allison is a very successful banker and knows more about banking than I ever will. I can’t just dismiss his remarks out of hand and cling to my “book value only” beliefs. I am going to have to clear some time on my schedule and test banks of a certain size based on growth rates and P/E ratios. I suspect that I will find he is right and I need to adjust how I look at the larger banks in the future.

He then rattled off a long list of banks that trade at higher P/E ratios than his but have much lower ROAs and higher efficiency ratios. Based on that list he thinks his shares are undervalued relative to the rest of the industry. He backed his opinion up with cash, as his earlier this year he exercised his option on more than 100,000 shares and simply kept the stock.

He thinks the future remains bright. His company is looking to do more deals in Florida and he says he has a team on the ground there ready to go when he finds a new acquisition and comes to terms. He told me his ROA right now is about 1.7% and he sees no reason he cannot work that up to 2% before too much longer. The already-efficient operation is looking to improve further and he is targeting a 35% efficiency ratio compared to the industry average of right around 60%. He told me that everything he does will be in shareholders’ best interest and I believe him, because he and his family own 11 million shares of Home Bancshares and are the largest shareholder.

Did he convert me? Almost, but not entirely. I would break out in hives if I paid 3.8x and 18.9x earnings for a bank. However, his bank is priced at a discount to peers that do not perform as well as his does and could be considered cheap compared to similar institutions. I also think his size and valuation argument makes a lot of sense, and if we see a sector and/or market decline that brings the stock to a P/E of 15 or so I might get hives if I don’t buy it at that level.

After speaking with Mr. Allison I knew I had a bunch of spreadsheet time ahead of me. His suggestion — that as a bank moved up in asset level, its price-to-earnings ratio and performance became much better valuation factors than price to book — made sense to me at some level.

I have never really thought about the idea, as I have always done just fine buying smaller, underperforming banks and then selling them to the high performers for a lot more than I paid. However, when you have been around as long as I have, you know there is more than one way to skin a cat — and Allison has made a lot of money in banking, so I needed to test the idea.

The data suggests that he is correct. Buying a portfolio of higher-performing banks, as measured by return on assets, that have strong, recent earnings growth, does indeed beat the market. I looked at banks with 15% earnings growth and returns on assets over 1.5%, with P/E ratios less than 20. You outperform very nicely over the 15-year period, and crush it over the last five years.

Looking at a 10-year period, you lag the market a little, because you really get killed in 2007 and 2008 before rebounding very strongly in 2009. From 2011 fonward, this approach outperforms the market by 60%. Buying the highest-performing banks does offer market-beating returns over time, but it can be a bouncy ride.

We can markedly improve results by “Timming-up” the approach, a little. I took the top-performing banks with strong earnings growth and then limited my purchases to just those with a P/E ratio of 15 or less, and a price-to-tangible-book-value ratio of less than 2. Returns improve dramatically, and they do so in my favorite fashion. The portfolio does much better in 2007 and 2008, and this improved defence allows the model to outperform over the five-, 10- and 15-year timeframes. Over the past five, the model has outperformed the S&P 500 by about 70%, as banks have recovered from the credit crisis.

The current screen of reasonably valued, high-performing banks has some interesting names on it. BankUnited (BKU) has done a nice job of growing earnings and share price since it was recapitalized during the credit crisis. At 1.43x book value, the stock would not usually show up on my radar screen, but with an ROA of 1.15% and 30% earnings growth over the past year, the stock makes the grade under this approach. The P/E ratio is just 13, so the stock passes the growth bargain test.

I am bullish on Florida banks in general, and BankUnited has been one of the best-performing banks in the Sunshine State over the past few years. You get paid to wait for growth with this stock, as BankUnited shares yield 2.66% at the current price.

Porterville, CA-based Sierra Bancorp (BSRR) makes the grade as a growth bargain bank, as well. The bank has been making whole bank and branch acquisitions lately, and it is paying off for them. Earnings have grown by about 17% annually for the past five years, and are up 23% this year.

The bank is reasonably priced — at 120% of book value and 12.5x earnings. The bank is earning a ROA of 105%, right now. You get a decent dividend with this stocks as well, as the shares yield 2.79% right now.

I was delighted to see that Hoquiam, WA-based Timberland Bancorp (TSBK) made the list. I originally bought this bank as a book-value bargain, and have been delighted to see than management has grown book value – and the book-value multiple has been increasing.

Earnings are up 45% this year, and have grown by more than 30% on average over the past five years. The return on assets is 1.23%, so they are performing much better than many of their small-bank competitors. In spite of the excellent performance, the shares trade with a P/E of just 11, and are at 1.3x tangible book value.

Allison is correct that you can pay a higher multiple of book value for banks that are top performers with strong earnings growth and high ROAs. While his bank didn’t make the current list, a little digging showed that Home Bancshares was a growth bargain right before the shares took off on a strong run — which has seen the share price almost quadruple.

The biggest takeaway from myconversation with Mr.Allison was that his approach to growing his Arkansas-based bank is a total validation of my process in picking small-bank stocks.

Allison told me that the way to make money was to buy the broken and underperforming banks, fix them up and increase their profitability. That’s almost exactly what we are trying to do as investors.

We are looking for underperforming banks trading at bargain prices with the intent of profiting when they begin to grow assets and earnings, or as is often the case, throw in the towel and sell to a larger financial institution. Both outcomes are profitable for us as outside investors, and we try to tip the odds further in our favor by focusing on those names that have activist investors pushing for profit and stock price increases or a sale of the bank.

When I look at this approach and crunch the numbers it is by far the most effective method for individual investors to use when investing in bank stocks. Buying banks with a lower-than-average return on assets (ROA) when the shares trade below book value outperforms the market over the five-, 10- and 15-year periods.

During the credit crisis this approach outperformed by being primarily in cash. At the end of 2007 there were almost no banks trading below book value. Bank deals were taking place above 2.5x book value, credit conditions were deteriorating and any bank investor with an ounce of prudence, caution and common sense was in cash. Since the crisis returns have accelerated and I expect that trend to continue as the pressure to grow or sell becomes even more intense.

When I ran a screen looking for banks with below-average ROAs that trade below book value, there are still plenty of candidates for a “trade of the decade” portfolio. My most recent purchase, Green Bancorp (GNBC), has bumped up a little in price but still remains attractive. The Houston-based bank has an ROA of just 0.43% and the shares are trading at just 95% of tangible book value. Green has private equity ownership of 13% and I can promise you that the three firms that control that 13% are looking to get paid off with a much higher stock price over time. CEO Manny Mehos has started, grown and sold a bank before and I suspect that is his eventual end game for Green as well.

I have owned Eastern Virginia Bancshares (EVBS) for a while and been pretty pleased with the results. It hasn’t been spectacular, but EVBS has provided a solid return and it has done a nice job of expanding its presence in both the Tidewater and Richmond markets. The bank has made some smart acquisitions and is working to get asset levels to the point it can achieve the scale needed to increase profitability. And EVBS has plenty of incentive to keep growing or consider selling as Wellington, FJ Capital, Castle Creek Partners and PL Capital are all significant shareholders.

The bank is making solid progress. In its most recent earnings release CEO Joe A. Shearin pointed out that “For the first quarter of 2016, as compared to the same period of 2015, we are reporting an increase in net income available to common shareholders of 60.3%, an increase in annualized return on average assets of 22 basis points to 0.70%, and an increase in annualized return on average common shareholders’ equity of 271 basis points to 8.34%.” The stock is still a bargain at just 91% of tangible book value.

When I ran this screen I came up with 123 candidates. But only 20 of them have market caps of more than $100 million. To participate in the big gains I see developing in community bank stocks you have to think small. It is the smaller banks that will sell out at a profit, so you need to give up any high-tech dreams and medical miracle expectations you might have when trading larger-cap stocks in order to participate in the trade of the decade ( I may need to change this to trade of the half-century).

There are no sure things in investing but buying a small bank in sound financial condition with a lower-than-average ROA and at least one activist shareholder is about as close as I think we will ever get.

Just the Numbers

rich

​Why should you join Banking on Profits monthly?

Because it will help you make money! Each issue has the information and ideas you need to make money investing in the Trade of the Decade.
Banking on Profits May 2015 bonus picks are up 15.02% vs SPY -2.29.

2-15 BOP we covered 7 banks with insider buying below book value. 6 of 7 are up , avg gain 27.21% vs SPY -.82%​

2-15 BOP we found 3 stocks with recent 13d Filings. All 3 are up. Avg gain 21,76% vs SPY -.82 ​

Banking on Profits Monthly added bonus picks last April. That months picks are up an average of 16.66% vs SPY -1.36​

4-15 BOP covered 4 13d filings. All 4 are higher with avg gain of 14.01& compared to -1.41 for spy​

In May 2015 BOP found 8 stocks insider buying at book value or less. 7 of 8 are up avg +12.25 vs -2.35 for SPY

In the March 2015 issue of BOP Monthly we covered 4 13D filings. All 4 are higher.average is 16.26%​

n 3-15 edition of BOP Monthly we found 20 stocks with insiders buying at or below book value. 16 of 20 are higher, total return 15.11%​

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The Conversion Opportunity

rich

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

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Listen to what bankers, investment bankers and industry experts are saying about the trade fo the decades in small banks.

Activist investors are increasingly campaigning against US financial institutions (FIs), a move driven by changes in the activists’ approach and an increased alignment with regulatory objectives, according to Fitch Ratings.- Fitch Ratings

Bank CEOs and their boards are feeling intense pressure to grow their institutions. Sixty-seven percent of the bank executives and directors who responded to Bank Director’s 2016 Bank M&A Survey believe their bank needs to grow significantly to compete in today’s marketplace. When asked how large their bank needs to be to compete, a slim majority—one-third—cite $1 billion in assets. Shara agrees, referencing a competitive and costly operating environment. “Scale is so important today. We all have similar regulatory and compliance costs, and you have to spread that over a bigger base,” he says.- Bank Director Magazine.

But smaller banks across the country can attest that in today’s environment such challenges are not confined to midsize and large financial institutions. For the past several years, headwinds facing community banks have driven record levels of bank consolidation. Since 2013, more than 700 U.S. banks have merged with or been acquired by another institution. During the same span, the number of FDIC-insured banks has declined from 7,083 to 6,270, with Arkansas experiencing a drop from 120 to 106 such banks. This consolidation has been heavily weighted toward smaller community banks, with more than 90 percent of acquired banks holding less than $1 billion in assets. The trend doesn’t appear to be slowing — analysts expect banking to remain an active deal sector in 2016 as community banks become even more attractive to their larger counterparts, and this week the CEO of the Consumer Bankers Association predicted that one in six banks nationwide will ultimately be forced to merge. Each of these acquisitions requires not only a buyer in search of growth opportunities, but a determination by the target that the time is right to sell. Why are community banks increasingly deciding that now is the time?- Aaron Brooks, Arkansas Business.Com

Consolidation in the U.S. midtier regional banking sector is likely to continue as midtier banks (with total assets ranging from $10 billion-$50 billion) seek to expand their branch footprints and asset bases, according to Fitch Ratings. ‘Midtier banks have been active acquirers over the last year and this trend is expected to persist in 2016 and beyond as midtier banks continue to buy-up community banks struggling with growing regulatory burdens in a low rate environment,’ said Bain Rumohr, Director, Fitch.- Fitch rating Service

Hedge funds such as Ancora Advisors, Clover Partners and Seidman & Associates are buying up stakes in lenders across the U.S., from community banks to large regional lenders. Driving these investments is the view that ultra-low interest rates, lagging returns on equity and tough regulations will push more banks to merge, with buyers willing to pay a hefty multiple to a bank’s tangible book value. Activist investors interviewed by Reuters say another factor is exposure to energy-related loans, which is driving down the valuations of certain banks and making them all the more vulnerable to a takeover. “Bigger banks are back in the market doing deals,” said Ralph MacDonald, a partner at law firm Jones Day, who specializes in mergers and acquisitions. U.S. bank mergers and acquisitions volume rose 58 percent last year to $34.5 billion, according to Thomson Reuters data.-Reuters

A new study by Marshall Lux and Robert Greene reports that since the enactment of Dodd-Frank community banks have lost market share at twice the rate that they did prior to Dodd-Frank. The authors note that many of the regulations implemented pursuant to Dodd-Frank are not linked to the size of the institution, thus there are economies of scale in regulatory compliance. Thus, regulatory costs tend to fall proportionally heavier on smaller banks, which, in turn, tends to promote consolidation of the industry (as I noted several years ago when I predicted that Dodd-Frank would promote industry consolidation).- Todd Zywicki Washington Post

There has been a cumulative impact of M&A activity over the years. As of September 30, 2015, there were 6,270 insured depositories compared to about 18,000 institutions in 1985 when interstate banking laws were liberalized. M&A activity when measured by the number of transactions obviously has declined; however, that is not true on a relative basis. Since 1990, the number of institutions that agreed to be acquired in non-assisted deals ranged between 1.4% (1990) and 4.6% (1998) with an overall median of 3.2%. Last year was an active year by this measure, with 4.4% of the industry absorbed, as was 2013 (4.5%). What accounts for the activity? The most important factors we see are (a) good asset quality; (b) currency strength for many publicly traded buyers; (c) very low borrowing costs; (d) excess capital among buyers; and (e) ongoing earnings pressure due to heightened regulatory costs and very low interest rates. Two of these factors were important during the 1990s. Asset quality dramatically improved following the 1990 recession while valuations of publicly traded banks trended higher through mid-1998 as M&A fever came to dominate investor psychology. Today the majority of M&A activity involves sellers with $100 million to $1 billion of assets. According to the FDIC non-current loans and ORE for this group declined to 1.20% of assets as of September 30 from 1.58% in 2014. The most active subset of publicly traded banks that constitute acquirers is “small cap” banks. The SNL Small Cap U.S. Bank Index rose 9.2% during 2015 and finished the year trading for 17x trailing 12 month earnings. By way of comparison, SNL’s Large Cap U.S. Bank Index declined 1.3% and traded for 12x earnings. Strong acquisition currencies and few(er) problem assets of would-be sellers are a potent combination for deal making. Earnings pressure due to both the low level of rates (vs. the shape of the yield curve) and postcrisis regulatory burdens are industry-wide issues. Small banks do not have any viable means to offset the pressure absent becoming an acquirer to gain efficiencies or elect to sell. Many chose the latter. The Fed may have nudged a few more boards to make the decision to sell by delaying the decision to raise short rates until December rather than June or September when the market expected it to do so. “Lift-off” and the attendant lift in NIMs may prove to be a non-starter if the Fed is on a path to a one-done rate hike cycle.- Mercer Capital Bank Watch

The report from Mercer Capital report says that” pricing in terms of the average price/tangible book multiple increased nominally to 142% in 2015 from 139% in 2014. Our average holding trades for 94% of book value and the current buy list is priced at an average price to book value of about 81,4% of book value. That’s about 75% below the current average multiple right now.

We returned 18.07 in the main portfolio last year wth 8 takeovers after having 10 in 2014. Out 14 sold holding since inception have averaged a total return of about 60% from the original purchase price. This is opportunistic value investing at its finest. We have banks that need to buy, banks that need to sell and this creates the extraordinary opportunity I call the Trade of the Decade.

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Tim