Too Big To Fail? What About Too Small To Be Noticed?

| About: HomeTown Bankshares (HMTA)

In this day of "too big to fail" and the government bailouts of numerous major financial institutions and investment firms, have you ever wondered about the opposite end of the spectrum? I mean the small community banks that dot the landscape of rural towns and cities, run by honest neighbors, and lending to those that meet certain qualifications. I'm talking about banks that were started by small businessmen and professionals that were tired of getting approval from places like New York, San Francisco and Charlotte, and instead called up their local loan officer in places like Hattiesburg, Poughkeepsie and Roanoke? While one theory is that these small banks are not a particularly good investment due to over-regulation and other difficulties, it appears that in certain circumstances, they may be worthy of consideration.

One circumstance is when the security is not followed by any major analyst, and consequently only those closely associated with the business may be in a position to know its true value. For instance, let us consider Hometown Bankshares (OTCPK:HMTA). This micro-cap bank headquartered in Roanoke, Virginia, has only 4 branches and no institutional following. Originally founded in 2004, the stock price has fallen from an IPO price of $10.00/share to its current price of $4.50. With a market cap of a mere $14.7 million, the stock has a P/E ratio of only 3.79.

From its latest report in November 2012, the bank reported 3rd quarter pre-tax earnings of $876,000 compared to pre-tax profit of $637,000 the previous 3rd quarter. Core earnings remained strong with $1.1 million realized in the third quarter of 2012 and $3.1 million realized for the nine months ended 9/30/12 compared to $998,000 and $2.3 million for the same periods in 2011.

Interestingly, the number of shares of Hometown Bank traded on a daily basis is often zero. When shares do trade, the numbers commonly are less than 1,000. But with the recent positive results of third quarter 2012, the volume increased dramatically, but still at microscopic levels:
11/29 - 5,600
11/30 - 5,400
12/3 - 2,900
12/4 - 4,200
12/7 - 7,300
12/17 - 7,300
12/18 - 2,800
12/19 - 4,000
12/20 - 3,600
12/21 - 10,000
12/28 - 16,000

Perhaps a few small investors who recognized the positive earnings picked up a few hundred shares.

Finally, another positive development with Hometown Bankshares is the elimination of its status as a TARP bank. The preferred shares previously held by the Treasury Department were put back on the open market. While the bank had "opted out" of the auction process in an effort to re-purchase the shares, according to the Chairman of the Board William Rakes, the Treasury Department changed the rules and allowed the shares to be sold at auction. Taken from a recent newsletter published by the bank, Rakes states:

In my last quarterly message, I described the "opt-out" program announced by the United States Treasury whereby smaller banks were permitted to opt out of the auction process and acquire or redeem their outstanding preferred shares purchased by the Treasury under the TARP Program. We should not be surprised that the Treasury changed the rules during the process and actually put our shares in an auction. We were disappointed that we were outbid by twelve institutions who acquired our preferred shares at amounts substantially higher than we expected. Consequently, we were unable to reap the savings expected by acquiring our shares at a substantial discount to par. However, the good news is that our shares were valued highly by knowledgeable institutional investors and that we are no longer a TARP bank and are relieved of burdensome reporting requirements and restrictions which were in place as long as the Treasury held the shares.

While there are certainly negative aspects of owning small community banks with low trading volumes, such as the occasional difficulty of selling the shares or the inability to liquidate them quickly, they do offer an interesting alternative to the huge money center banks and their complex annual reports. There is something to be said for simplicity and transparency and often times those traits are found in micro-cap issues with few followers.

Another option to investing in community banks is the QABA - the First Trust NASDAQ Community Bank Index Fund.

Hometown Bankshares, doing business in the Roanoke and New River Valleys of Virginia, is only an example of the many community banks that dot the American landscape. Find one in your area, visit a branch and review their latest reports. You might find something you like and that has been overlooked by Wall Street.

Disclosure: I am long OTCPK:HMTA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I was a small initial investor in the HMTA initial public offering and have added small amounts to my position in recent years.