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Small Banks, Big Value

 

 

One of the most consistently undervalued sectors in the country has been very small regional banks.  The reasons aren’t hard to understand, if the company is too small it’s easy for a mutual fund to become a beneficial owner in a bank and nobody wants to deal with that.  The result is a stock that is somewhat void of large institutional ownership and is a bit off the radar, even more than small cap stocks usually are.

 

The recent bank problems have actually helped this out quite a bit.  Not just the obvious of investors rushing away from smaller bankers that aren’t “too big to fail” but the fact that some took TARP money.  That in itself isn’t a bad thing, it’s pretty cheap money and most banks know it.  The side effect is that banks that are undervalued cannot institute any sort of stock buyback program while they still have TARP money that needs to be repaid.  This gives smaller investors a longer time frame to take advantage of the discounts.

 

Take for example Parkvale Financial Corp. (NASDAQ:PVSA).  The company had a rough first quarter of 2009, losing $2.67 per share but quickly rebounded into profitability.  The next three quarters ended with gains of $3.81, $.42, and $.48 per share with a share price ranging from $6.41-$11.75 in the last 52 weeks.   Not amazing, but certainly not bad enough to justify the price to book ratio it’s selling at.

As of March 24th the market cap of Parkvale was $43.21 million while its book value as of the last quarterly report (12/31) was just a shade over $150 million.  I don’t think a lot of people will debate that selling at 1/3 of book value on a company that has weathered the recent financial crisis profitably is a bad deal.

Once the dust has settled we’ll possibly see a wave of consolidation in the banking industry, with larger regional players swallowing up the smaller ones.  It will be hard for the biggest banks to expand very much since the top 3 are bumping up against the 10% of total deposit limit.  U.S Bank (NYSE:USB) would be a good candidate for a spending spree in the Northeast or Deep South where it currently lacks any meaningful presence.  Usually buyouts don’t take place at a significant discount to the book value when the economy seems stable. Granted you may have to feel that the worst is over in order to see the opportunity in this market, but if you do it’s hard to avoid the logic.

Since stability and loan prudence are such a big deal right now when it comes to investing in finance companies, most banks are going out of their way to comment on any conservative methods used to make loans or to buy loans from other banks.  A brief search through banks annual and quarterly reports will be the main resource to use for these.  Look for banks that have consistently required 20% down payments for any non-insured loans that they originate or buy.

 

For those value investors out there looking to find a deal in a stock market that has surged 42% in the last year look no further than community banks.  Between the fear still left to be shaken out of small financial stocks, a possible upcoming wave of consolidations, or even just the fact that the majority of Americans are angry at their current large bank, it’s a segment well worth researching.  I don’t pretend that it isn’t a lot of work, since the best deals will be with banks that have very limited analyst coverage, but if you can do the digging and diversify yourself across a fairly broad geographical footprint you should be able to hunt down some pretty good stocks at rock bottom prices.



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.