One of the most interesting sectors in recent years for exploration has been regional banking. Regional banks are often tiny, serving a small geographic region or community. However many banks of this size (typically well under $1 Billion in market cap), in my mind, retain a significant advantage over their larger counterparts for several reasons:
1. Depth of management.
The management of these small banks often hails from the area in which they are located, giving them an intimate understanding of the community in which their business operates and it's specific needs - allowing them to tailor services and to make prudent decisions reflecting their experience "on the ground." In addition, there is often significant insider ownership which helps to encourage the prudent stewardship of shareholder capital.
2. Partial insulation from volatility affecting large money center banks
By virtue of obscurity and low volume, shares in regional banks are often less subject to broader market carnage that can plague their larger cousins. As they are smaller operations with simpler balance sheets, regional banks are also often absent from national media and receive much less bad press when bank-related turmoil occurs.
3. Opportunities for organic growth into nearby areas.
As long as it does not destroy long term value, growth is a good thing. I believe that some regional banks are well positioned to continue slow and stable growth into nearby geographic areas, through acquiring nearby regionals. A bank with intimate experience in the market of one state is likely to have at least some traction with the market one state over. You probably have some knowledge of your nearest neighboring municipality - right?
Republic Bancorp and the Regional Advantage
Republic Bancorp (NASDAQ:RBCAA) retains these three advantages. RBCAA has 50% insider ownership, a factor which increases a commitment to a sustainable and prudent business practices by virtue of managements direct financial interest in the ongoing profitability and safety of the enterprise. Per RBCAA's 10-K, their tier one and total capital to risk ratio's are, at 23% and 24% respectively, more than twice as high as the regulatory minimums and have been growing since 2007. RBCAA was also able to increase its dividend through the course of the 2008-2009 turmoil, no small feat considering the performance of its larger cousins (C, BAC) during the same period. RBCAA has continued to increase its dividend for over ten consecutive years. With the acquisition of the assets of the Tennessee Commerce Bank, RBCAA has been able to organically increase its regional presence.
The current price of RBCAA is $22.03 per share, with a P/E ratio of 3.9, a dividend yield of 3% and an EPS for 2012 of 5.65. Book value is at $26.63 and cash per share is $4.59, over a 40% difference from the current price. In addition the company paid a special dividend of $1.10 on every A share in late November, representing a return of 5% of shareholder cash. Though I liked the free cash, I would have preferred to receive a stock dividend in the company for the same percentage amount for reasons which I hope by now are obvious. Waiting for the market to revise RBCAA to book value could produce a substantial, "cigar-butt" style return. However I think there is reason to take an even longer term approach…
Buffett's concept of the Equity-Bond and why RBCAA could be a great long term hold.
I believe Buffett's concept of an Equity-Bond, a hypothetical class of common-stocks that has the potential to create considerable shareholder value over time can be applied to RBCAA, which in my opinion retains a durable competitive advantage through its organic growth, involved management and providing a basic, essential service to the communities in which it operates. Buffett wanted to see companies that could compound their retained earnings and use those to generate more earnings at a strong and sustainable rate. A more detailed explanation can be found on this website, or the book Buffettology by Mary Buffett.
In short: If one were to divide the EPS by the price of the stock, and if the result was greater than the yield of a corporate bond by a significant margin, AND the company retained a durable competitive advantage, the purchase of shares would be merited.
Let's do some math:
RBCAA's 2012 EPS: 5.65
Current price of $22.02
(5.65/22.02)= a 25% "coupon"
We might just have an equity bond here…