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As discounts to book value have evaporated in many small banks, a few opportunities have yet to be realized. Timberland Bank (NASDAQ:TSBK) and First Business Financial (NASDAQ:FBIZ) have been largely overlooked by investors. I began my career on the buy-side in 1997 analyzing banks and thrifts and have seen this before in banking cycles, where a few small, yet reasonably healthy banks are still trading at significant discounts to book value late in the recovery cycle.

Two banks trading at steep discounts to their tangible book value are Timberland at $5.20 is 56% of tangible book value of $9.31 and First Business trading at $13.4 is 61% of its $21.67. I expect both of these bank stocks to rise sharply in the near term.

Mike Sand, the current CEO of TSBK, has been affiliated with the Bank since 1977; he has been the CEO since 2003. Mike has seen the successfully navigate bank through several lending cycles. Dean Brydon has been affiliated with the Bank since 1994 and has been in the CFO position since 2004. I have been impressed with Dean’s knowledge of accounting and his analysis was a major force in the Bank’s ability to steer successfully through the Northwest’s real estate issues.

So why has the market mispriced TSBK? I think there are two reasons. Reason #1, SNL (the data source used by most institutional bank investors) has the NPA’s bulked together with the TDA’s (Troubled Debt Restructurings). Timberland’s loans that have had interest rate reductions or extensions have been bulked together with non-performing loans. The bank reports non-performing loans at about 5% of assets, and SNL has this number closer to 8%. The 3% difference is mostly comprised of a storage unit property in Washington State that has had its interest rate reduced while it fills its units. I believe that this property is filling up as planned and will return to the initial agreement. If this occurs on my timeline the NPA’s listed in SNL for this bank will drop dramatically.

Reason #2, investors in Northwest banks have had the painful experience of FDIC forced recaps at discounts to book value. I believe that the marketplace expects TSBK to raise money in the capital markets to boost its tangible common equity to pay back TARP (Troubled Asset Relief Program). In my opinion, this belief is absolutely incorrect. First, the bank is exceptionally well capitalized. The total risked based and tangible common equity for this bank is about two times the required levels. Second, I have done the analysis and it is my opinion that the bank can completely pay back the TARP without dipping below required capital levels or raising any capital.

The Bank is under an MOU (Memorandum of Understanding) that prevents it from paying any dividends without FDIC approval. In my opinion these MOU’s were handed out by the FDIC to thousands of banks so the FDIC could charge more for FDIC insurance (I obviously have no proof of this). A bank with an MOU will usually pay 300% more in FDIC insurance than a bank without an MOU. The FDIC insurance premiums move from 12 basis points to 45 basis points on deposits based on the risk category. However, better late than never, in the last few months I have seen many MOU’s removed. MOU’s are removed when the credit quality, capital levels or earnings of a bank improve. In the last year TSBK has had 3 profitable quarters totaling 35 cents of earnings per share and has a tangible capital equity of over 10%. I have confidence that its MOU will be removed in 2011. Once the MOU is removed, the bank may decide to pay back TARP in its entirety.

As I have mentioned, my analysis indicates that the bank can do this with current capital, in one payment. When the market sees that the bank has paid back its TARP obligation and is still well capitalized. I would expect the stock price to double. The stock is a little thin, as the market has shown with past announcements of positive earnings quarters so an investor will have to be there before the announcement to make money. Management has taken advantage of the stock price and taken positions to capitalize on future opportunities. Below are insider buys over the last 2 years

Dec 23, 2010

STONEY MICHAEL JOHNDirector

1,090

Direct

Purchase at $3.60 per share.

3,924

Dec 22, 2010

STONEY MICHAEL JOHNDirector

910

Direct

Purchase at $3.60 per share.

3,276

Dec 2, 2010

GOLDBERG LARRY DAVIDDirector

1,000

Indirect

Purchase at $3.40 per share.

3,400

Sep 14, 2010

PARKER JON CDirector

1,700

Direct

Purchase at $3.90 per share.

6,630

Sep 13, 2010

PARKER JON CDirector

1,000

Direct

Purchase at $3.90 per share.

3,900

Sep 7, 2010

PARKER JON CDirector

4,000

Direct

Purchase at $3.89 per share.

15,560

Sep 3, 2010

PARKER JON CDirector

1,300

Direct

Purchase at $3.90 per share.

5,070

Sep 2, 2010

PARKER JON CDirector

2,000

Direct

Purchase at $3.84 per share.

7,680

Aug 27, 2010

GOLDBERG LARRY DAVIDDirector

1,000

Indirect

Purchase at $3.50 per share.

3,500

Aug 26, 2010

GOLDBERG LARRY DAVIDDirector

500

Indirect

Purchase at $3.60 per share.

1,800

Aug 18, 2010

STONEY MICHAEL JOHNDirector

1,000

Indirect

Purchase at $3.80 - $3.94 per share.

3,8702

4,000

May 25, 2010

STONEY MICHAEL JOHNDirector

1,900

Direct

Purchase at $4.15 per share.

7,885

Nov 24, 2009

PARKER JON CDirector

1,000

Direct

Purchase at $4.24 per share.

4,240

Nov 20, 2009

GOLDBERG LARRY DAVIDDirector

2,000

Direct

Purchase at $3.60 per share.

7,200

Nov 20, 2009

MASON JAMES CRAIGDirector

1,000

Direct

Purchase at $4 per share.

4,000

Nov 10, 2009

MASON JAMES CRAIGDirector

1,000

Direct

Purchase at $4.40 per share.

4,400

N/A

Data provided by EDGAR Online

Of course there is the other potential outcome that TSBK’s twenty two branches will be acquired by one of the several consolidating Northwest banks. I believe that Timberland would be a perfect fit for Umpqua Bank or Columbia Bank. Both have tremendous levels of capital and the FDIC acquisition game in the Northwest is basically played out. These banks can either dividend excess capital back to shareholders, which I think management is very reluctant to do, or make profitable acquisitions. If I can paraphrase Melanie Dressel, at the last DA Davidson conference the CEO of Columbia Bank stated that “When you see us pay back significant capital to shareholders, you will know that we do not see ways to get a sizable return on that capital.” Columbia and Umpqua bank would add value to their franchises by looking at a book value transaction with Timberland Bank. The banks would add about $750 million in total assets, $600 Million in deposits, 22 full service branches and in my opinion about $7-$10 million of pre provision earnings power.

The second bank that investors should focus on is First Business Financial. FBIZ is a simple math story. The company is trading at 59% of book value and over the last four quarters has earned a total of $1.59 in earnings per share. This is a very sleepy bank that may continue to earn about 50 cents a share every quarter. With the stock trading at $13.4 there is very inexpensive opportunity for multiple expansion from a tremendous discount to book. However, my fund owns it primarily for an acquisition by a larger bank. It is my opinion that FBIZ will be bought at 1.5x tangible book value or about $32.50. Likely acquirers may be Old National Bancorp (NASDAQ:ONB), which just bought Monroe Bank for 1.5X book, Associated Bank (NASDAQ:ASBC), which is looking to add assets and deposits in Madison where university and government jobs are based, Wintrust (WTSC) and Private Bank (NASDAQ:PVTB). While I wait for one of these players to step up, FIBZ, a billion dollar institution, pays a solid dividend that may increase. With the bank producing earnings at a $2 annual rate, the downside at about 60% of tangible book value with about 3% NPA’s is minimal.

First Business has a presentation on its website that is very informative. I suggest that you do your own due diligence and read the presentation.

Both Companies, TSBK and FBIZ are long holdings for the fund managed by The Banker. The management company may trade these at any time. Consulting clients of The Banker may also own these names and have no trading restrictions. This article contains forward looking statements and should not be misconstrued with assurances of gains.

Source: Deep Fundamental Values in 2 Banks That Should 'Print You Money'