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Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly-managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices. -- Warren Buffett, in his 1990 Chairman's Letter to Shareholders of Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B)

While I don't spend a lot of time looking at bank stocks, every once in a while, I run a screen to try and find a well-managed bank selling at a fair price.

Last year, on the premise that banking is a commodity business in which the low-cost provider has a competitive advantage, I searched for banks that sported both lower borrowing costs and higher net interest margins than Buffett favorite Wells Fargo (NYSE: WFC). That led me to a few interesting names, including Westamerica Bancorp (Nasdaq: WABC) and SVB Financial Group.

Today I've done something different, taking the above quote a bit more literally.

As a proxy for management quality, I've decided to screen for both a solid average return on assets (1.25% or better) and respectable growth in tangible book value (at least 8% compounded) over the past seven years. To try and weed out reckless lenders, I've limited my search to banks whose nonperforming loans represent fewer than 5% of total loans. As for a fair price, I'm looking for banks trading at less than twice tangible book value.

How many U.S. bank stocks do you suppose meet these basic criteria? 100? 50? Try 17. Here are the eight largest:

Company

Market Capitalization

10-Year Avg. Total Return Through 12/31/09

Motley Fool CAPS Rating (out of 5)

Capital One

$19,090 million

0.0%

*

International Bancshares (Nasdaq: IBOC)

$1,360 million

9.5%

*

CVB Financial

$1,011 million

8.5%

**

PacWest Bancorp (Nasdaq: PACW)

$784 million

n/a

*

BancFirst Corporation

$562 million

10.2%

*

Bank of the Ozarks (Nasdaq: OZRK)

$505 million

21.3%

*

Nara Bancorp

$436 million

18.8%

*

SY Bancorp

$297 million

10.1%

*

Total return data courtesy of Morningstar.

That CAPS star rating is out of a possible five, by the way. Clearly the Motley Fool community doesn't think much of these stocks! But note the firms' 10-year returns, which look quite good compared to a ghastly performance by the overall industry (or the broader stock market, for that matter). Surely at least one of these banks will continue delivering for shareholders, no?

A sad day for value hounds
At around 6.5 times pre-tax earnings and 10.7 times after-tax earnings, International Bancshares is arguably the cheapest of the lot. That's fairly depressing, given that Buffett accumulated 10% of Wells Fargo in 1990, another period of serious disarray in the financial sector, at less than half this valuation. Fortunately, IBC has a guy in a bee costume on its website, which cheers me up somewhat.

As far as fundamentals go, IBC doesn't particularly stand out from the group, aside from having the strongest Tier 1 capital ratio (17.2%). Interestingly, that didn't stop the firm from participating in the Treasury's TARP program. For political reasons, the country's large banks really had no choice but to take the money. (They're now racing to return it.) But there were plenty of strong, smaller banks that were willing to take a pass on TARP and all its attending restrictions. IBC reported last quarter that its "strong earnings substantially neutralized the cost of the TARP funding," but it seems that earning power was still diverted unnecessarily.

California beauty, only skin deep?
Another TARP recipient, CVB Financial (NASDAQ:CVBF), impresses me with its $300,000 in revenue per employee. I love a company that can do more with less. This metric suggests a higher degree of automation than is employed at firms like PacWest and BancFirst.

CVB explicitly targets a return on assets of 1.35%, a return on equity of 20%, and earnings growth of 15% a year. These are admirable targets, but the company hasn't seen results this strong since the 2004-2005 period of blissful banking.

My biggest issue with CVB, based in California's Inland Empire, is the firm's location, and consequent exposure to real estate loans in one of the bubbliest parts of the country. That consideration, combined with the fact that the bank put its name (Citizens Business Bank) on a local sports arena -- a folksy, yet potent, contrarian signal ranking up there with magazine covers -- is probably enough to keep me away.

A final thought
It's possible that I've gone about this search all wrong. By favoring growth in book value during a period in which a lot of dumb lending occurred, I'm penalizing firms that had the good sense to sit this activity out. Good sense is tough to screen for. If you have thoughts on other ways to identify well-managed banks, I'd love to hear them.

Source: What Does It Take to Find a Well-Managed Bank?