An Undervalued Regional Bank Offering Great Income Potential

| About: Southside Bancshares, (SBSI)

Value comes in many forms, many businesses and many sizes. A quote that encapsulates my philosophy in small-cap stocks came to me rather unexpectedly - from a sushi chef - who astutely quipped "even small fish are tasty when served correctly." Regional Banking has been a sector that I have been following for quite some time, as I believe there are considerable opportunities to be had in the right areas...if they are correctly served up to the investor.

Instead of using the "shotgun" approach to bank investing, either through investing in large banks with national exposure - including Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC) or through a SPDR ETF holding a variety of regional banks (NYSEARCA:KRE) - an investor can take the "rifle" approach - targeting specific regionals that are attractive by virtue of their intrinsic business characteristics and located in economically advantaged or resilient areas. In an earlier article, I discussed the potential behind an expanding regional bank in Kentucky, a position that I still hold and one that has fared well since I purchased shares in November. Today I will be discussing another regional bank, this time located in Texas, Southside Bancshares (NASDAQ:SBSI).

In my earlier article on regional banking, I outlined why I believe some regional banks can make good investments:

"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, [either organically or] 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 [county] over. You probably have some knowledge of your nearest neighboring municipality - right?

The Numbers on Southside
Currently priced at $21.28 against $15.92 of assets and $7.6 of cash per share, the bank currently is trading at a discount to total assets. The company is small, with a current market capitalization of $360 million dollars. In addition, the company offers a cash dividend rate yielding 3.76% annually. The company also enjoys capital ratios that are more than twice regulatory minimums, and a leverage ratio that is approximately 82% higher than the regulatory minimum to qualify as being a well capitalized entity - which can be found in the company's 10-K filings here. Though the dividend is subject to variability (as seen by reduced payments during the financial crisis of 2008), it has grown consistently over a 10-year period. Upon encountering an asset trading at a discount and offering a healthy and growing dividend, many investors will be willing to purchase shares outright - especially since Southside's dividend is higher than its gigantic peers including Bank of America and Wells Fargo. Also encouraging is the performance of Southside relative to Bank of America or Wells Fargo during the financial crisis - when both BAC and WFC declined significantly - SBSI's decline was much less precipitous, as seen in this chart, courtesy of Google Finance.

But wait, there's more!
Southside has also paid a stock dividend of 5% (splitting 21:20) every year since going public. Combining the 5% stock dividend with the variable, but growing 3.76% cash dividend offers investors an annual yield of 8.76% - not bad at all - especially when considering the potential of compounding and possible tax benefits of this payout structure. In spite of this attractive yield, it is also important to note that it is variable and linked with the price of shares. If Southside is able to continue to deliver slow and steady growth as it has in the past - it could represent significant rewards to patient investors. The company is also returning cash to shareholders through a repurchase plan, which was announced in November of last year.

Regional Deposit Marketshare
Per the company's investor relations website, which can be found here, the company has regional presence in several areas of Texas. In Smith County, which has the most Southside branches, Southside currently retains 44% of the deposit marketshare and nearly 48% of the deposit marketshare in the city of Tyler, Texas - the seat of Smith County. It's closest competitor in the county, Bank of America, has less than a 9% market share. Southside is also No. 2 in Lindale, Texas - a small municipality in Smith County, with 31% of the marketshare. In neighboring Gregg County, Southside maintains a smaller presence - with total marketshare in the county slightly north of 5%.

In addition to these two counties, Southside has branches that serve larger metropolitan areas including two branches in Fort Worth, one in Arlington, and two in Austin, and the company also operates a network of 48 ATMs.

Regional Advantages, Regional Risks
A big part of risk to investors when it comes to regional banks is that their fortunes will wax and wane with those of the broader community, be it the economy of the county or the state. In addition to more general risks related to interest rates, municipality solvency and real estate prices, a large portion of the industry in Texas is dependent upon the oil and gas industry. The company cited the collapse in oil prices in 2008 as being a major headwind for the economic growth of the area. In addition, per the company's most recent 10-K, the management of Southside indicate that an increase in the medical services sector and retirement relocation could drive future growth in the areas in which a majority of the business is located.

Final Thoughts
For investors concerned with obtaining a significant amount of passive income, I believe that Southside is a promising candidate for further research and investment due to both its growing dividend payments over the past decade, present discount and stock dividend. Despite these promising metrics, I would caution investors to carefully evaluate the economic conditions within the state of Texas, before making a commitment, particularly in the regions where Southside conducts its business. I would also be on the lookout for the company's expansion through mergers or acquisitions in addition to the possibility of the bank being itself acquired by a larger entity.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SBSI over the next 72 hours. 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.