In today's current economic and geopolitical climate, no one knows which direction markets are headed. With the intense activity taking place in the Federal government, it looks like the markets are in for a rocky 2017. However, amid the confusion, I believe there is a little-known equities category which could provide some satisfying returns for investors. I am talking about small-cap community bank stocks.
As of 2013, there were 6,416 community banks in the United States, according to the FDIC. In almost every town, from large to small, there are publicly traded banking institutions that survive and thrive off of intimately knowing their customers and being upstanding corporate members of their community. In doing so, they provide a unique selling proposition to customers who are deciding which banking institution to do business with. The success of these firms is often tied to their specific region, which is, in essence, the double-edged sword of community banks. As a whole, however, community bank stocks are poised for great performance in 2017 and for years to come.
The Pros of Investing in Community Banks
- Robust dividend yields
- Low volatility
- Increased earning potential
- Merger & acquisition opportunities
- Regional economic forces
The Cons of Investing in Community Banks
- Liquidity issues
- Costly banking regulations
- Regional economic forces
The first step in the process of evaluating and investing in community banks is to find out what banks are out there. Also, you must decide where you would like to invest geographically. Do you want to invest in an institution that is across the street or in another state? Do you want to invest in a fund which holds community banks, such as the PowerShares KBW Regional Banking Portfolio ETF (NASDAQ:KBWR) or the First Trust Nasdaq ABA Community Bank ETF (NASDAQ:QABA). Both of these funds would give you some exposure to the community bank arena but leave you missing out on some of the best aspects of community bank investments. You could also simply invest in the community bank in which you currently have accounts.
Personally, I recommend that you give serious consideration to banks within your local community. It is far easier to do research and get a true feeling for a business when you have been a customer yourself. You can also attend shareholder meetings with far more ease than attempting to attend one for a larger firm across the country. You can gain a lot of great information by reading company reports. However, it is another thing to personally attend a shareholder meeting and get a feel for where the company is going and how management will care for and grow your investment.
So how do you start the investment process? Once you have decided on your geographic area, you need to do research. As always, the SEC is a great tool to find all of the corporate reports companies are mandated to file. If you are specifically interested in finding community banks to invest in, you can utilize the search tools on The Independent Community Bankers of America website or those provided by the FDIC. Information on funds such as those mentioned above are readily available by doing a search for small-cap community bank funds online. You can also go directly to companies which sell other securities and inquire if they have any community bank funds.
For small community banks in particular, information can often be difficult to find using search engines or financially-based sites. Due to their size, the information published is often incomplete on many financial websites. In my experience, the simplest way to get information on community banks is the most direct. The next time you are near the bank, stop by and ask if you could have a copy of their annual financial report. If they do not have any copies at the branch or their report is not out yet, ask if they would be willing to mail you a copy once it comes out. Most often, the bank will mail you the report free of charge. Now that you know a few sources for investment research, let us go over the pros and cons of investing in small-cap community bank stocks.
Robust Dividend Yields
Dividend yields among community banks vary, but many community bank stocks have greater yields than those of larger banks. Of the community banks I have researched, the majority of dividend yields were between 3 and 6 percent. Community banks are often in a situation in which they have carved out a profitable regional niche. Therefore, instead of laying aside large sums of capital for expansion projects, most companies focus the brunt of their cash flow back to shareholders. Also, as with numerous larger firms, many community banks have dividend reinvestment plans which shareholders can enroll. If you plan to hold the stock for the long term, it is a nice option, because you can experience the wealth-generating magic of compound interest, dollar-cost averaging and zero transaction fees.
Since the volume of shares traded on a given day is relatively low (often as little as a few hundred shares), share prices do not change drastically over intermediate periods of time. This trend can be great for those who wish to purchase small-cap community bank stock as a savings tool or those who simply do not care for the daily upswings and downswings of the market.
Increased Earning Potential
In mid-December, the Federal Reserve announced its first rate increase for 2016. In addition, it announced three planned rate increases in 2017. When interest rates rise, the average bank will experience greater earnings. With positive economic data, such as 5% unemployment rates, the Federal Reserve had no choice but to make some of the first rate increases in years. Only time will tell how great an impact rate increases will have on individual community banks, but the trend is going to be a positive one.
Merger & Acquisition Opportunities
Since 1985, an average of 33.4 percent of small-cap banks in the United States have merged. The consolidation of community banks often results in decreased competition for regional territory and increased corporate profits. Also, community banks often save on costs by merging with their competitors due to economies of scale. Another benefit is when community banks are acquired by larger national banking organizations. Often, there are cash incentives for those who wish to relinquish their shares and enticing share conversion rates for those who wish to keep their holdings.
Regional Economic Forces
If the region in which a community bank operates is growing, and the bank can capture part of the growth, then it will increase its earnings and do very well. Community banks are deeply entrenched in their local territory. Many customers choose to do business with community banks because of the level of service and care which many of these banks give to local residents. In essence, the locality and involvement of community banks can often give them a unique selling proposition which can set them apart from their larger national competitors.
Often, community bank stocks are thinly traded, and many have daily volumes which are only a few hundred shares per day. If you are trying to unload large amounts of stock, this can be difficult, because you may not find enough buyers in the market to make your order go through on a given day. As a whole, liquidity issues make it hard to heavily invest in any one specific community bank.
Costly Banking Regulations
In 2014 alone, Dodd-Frank added over 19,000 pages of regulation on the banking industry. In the United States, regulation costs banks over $78.9 billion annually. The banks which are hit the worst by these costs are small community banks. The fact that regulations can represent a far higher share of their incomes than larger banking corporations impacts community banks the most. Banks throughout the United States are continuing to consolidate in order to share regulatory costs by taking advantage of economies of scale.
It is unknown if banking regulations will continue to grow or be reduced in the coming year under the changing political climate. Since the financial crisis of 2007-2008, increased bank regulations and regulatory costs have been the trend. However, President Donald Trump stated throughout his campaign that he would "dismantle Dodd-Frank". With a new administration in the White House, only time will tell if the president will dismantle Dodd-Frank and lessen the financial burden felt by small banks.
Regional Economic forces
If a region is stagnant or in diminishing economic state, it may be very hard for community banks operating in that region to survive and thrive. Such stagnation or shrinkage of a local market would have a direct negative effect on earnings and share prices. Since the banking organization is so entrenched in the local marketplace, any economic shift is directly felt by community banks and their earnings. If a bank focuses on the wrong region, it is very unlikely to be a good long-term investment.
Now I am going to briefly go over two community bank stocks. Each company brings with it different characteristics to evaluate when making investment decisions. Hopefully, after reviewing these banks, you will get a feel for how different one community bank can be from another. Even though they are within the same sector, both of these stocks are geared towards two very different kinds of investors.
Kish Bancorp Inc. (OTCPK:KISB)
First, I am going to go over a stock which I have experience with and which I currently hold - Kish Bancorp. The bank is headquartered in Belleville, Pennsylvania. It operates thirteen offices in Mifflin, Huntingdon and Centre counties. All of these counties are located in Central Pennsylvania. The operations of Kish Bancorp include banking, insurance, financial solutions and travel. When it comes to community banks, Kish is on the small side. Its current market cap is a mere $57.28 million, and it trades on the "over-the-counter" market or "pink sheets."
Currently, Kish Bancorp is trading at $46.10 a share, which gives the company a dividend yield of 3.99% and a price-to-earnings ratio of 12.35.
Univest Corp. of Pennsylvania (NASDAQ:UVSP)
Univest Corp. of Pennsylvania is a small-cap community bank stock corporation headquartered in Souderton, Pennsylvania. Its operations are divided into three segments: banking, insurance and wealth management. It operates primarily in Bucks and Montgomery counties of Southeastern Pennsylvania. When it comes to community banks, Univest is on the larger side with a market cap of $732.92 million, and it trades on the Nasdaq.
Currently, it is trading at $27.35 a share, which gives the company a dividend yield of 2.93% and a price-to-earnings ratio of 30.31.
Comparison and Evaluation
Both Kish Bankcorp Inc. and Univest Corp. of Pennsylvania are small-cap bank stocks with exposure to different regions of Pennsylvania. Both companies have respectable dividend yields. Kish has a slightly higher dividend yield of 3.99%, compared to Univest's 2.93% yield. Both companies are poised to either maintain or grow their dividends in the years to come. When it comes to share prices, Univest is more volatile. Since it has a greater market cap and volume, the share price moves more actively. Also, a higher average volume means investing in Univest would give you fewer liquidity issues than investing in Kish might.
Both companies are positioned well to increase their earnings with the rise of interest rates and the potential for decreased banking regulations in future. In the meantime, regional economic forces play a critical and continuous role in the earnings of each firm. For Kish Bancorp Inc., Mifflin and Huntingdon counties are stagnant markets which offer little chance of growth. Meanwhile, the Centre county market is steadily growing. Kish Bank is currently focusing its investments into Centre county, which has helped its bottom line significantly. On the other hand, Univest Corp. of Pennsylvania, which has entrenched itself in Bucks and Montgomery counties, is poised to grow more rapidly. Currently, Bucks and Montgomery counties are the two richest in Pennsylvania and have great future growth prospects.
I believe both companies would be good investments under current market conditions. Both will experience the positive effects of interest rate increases and the possibility of deregulation. If you are an income-focused investor, you may tend towards an investment in Kish Bancorp. Meanwhile, those who prefer greater liquidity would probably tend toward an investment in Univest Corp. with its higher volume.
When it comes to which firm operates in a stronger regional economy, Univest is better positioned. Although the marketplace it operates in is growing faster, the company's share price reflects it. Currently, Univest's price-to-earnings ratio of 30.31, which is almost three times Kish's price-to-earnings ratio of 12.35.
When it comes to which company is fairly priced, I would say both firms have reasonable share prices. Univest's P/E ratio signifies that its stock is slightly expensive relative to how fast its market is growing. At the same time, Kish is priced fairly for its relatively slower regional market growth. In the end, the decision of which company to invest in comes down to the type of investor you are. Those who are more risk-averse and income-oriented are those who would prefer to invest in Kish Bancorp. Those who are less risk-averse and capital gains-oriented will by far decide to make an investment in Univest Corp.
I hope you enjoyed this article and maybe even learned something along the way. I believe when everything is taken into consideration, it makes a lot of sense to buy and hold community bank stocks. With the stock market near record highs, why not collect some nice dividends and capital gains from community bank stocks? As I stated earlier, there is a lot to take into consideration when selecting how and where you want to invest in community banks.
My preference is to find and invest in individual community bank stocks. Specifically, ones that are making investments in territories which are economically strong. However, I believe small community banks as a whole are going to do very well in 2017 and for years to come. Regardless, you just have to watch out for those banks entrenched in weakening economic markets. With interest rates still at historic lows, it is always nice to hold securities with good yields and a good future outlook.
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Disclosure: I am/we are long KISB.
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: This article is for informational and educational purposes only and should not be construed to constitute investment advice.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.