When most investors talk about financial stocks they tend to think of the bigger bank stocks. Certainly when the media talks banks, it is usually Bank of America (BAC) or Citigroup (C) that are discussed.
But while these banks have recovered nicely form the depths of the credit crisis and dominate headlines, the real story in bank stocks today is in the much smaller banks across the country.
These small financial stocks are the banks that do not have large trading or investment banking operations and are dependent on things like net interest margins and loan demand to earn profits.
Also, these small banks face strong headwinds from the increasingly expensive regulatory environment and the lack of new loan demand — and oddly, their headwinds can provide strong tailwinds for your investment portfolio as the smaller financials merge or are bought out by larger players
Smaller banks are finding that the costs of new regulations and eventually new capital ratios are making it expensive to stay independent. On top of that, tighter lending rules and a continuing weak economy make organic growth almost impossibility.
The only reasonable path of banks with less than $2 billion of assets is to merge with a larger bank or take over a competitor to spread the costs and gain earnings growth. Right now the always short term quarterly focus on earnings has many of these smaller banks trading at a discount to book value and this is creating a significant opportunity.
ESSA Bancorp (ESSA) is in the sweet post of what could be the most profitable investment theme of the next 10 years. The Stroudsburg Pennsylvania based bank has 26 branches and about $1.3 billion in assets. The bank has a solid portfolio what nonperforming assets at less than 2% of total assets. The bulk of the loan portfolio is single family housing and they appear to have been far more conservative than many banks in their lending practices during the boom before the bust. The stock trades at just 80% of tangible book value so there is some substantial upside in the stock over the next few years.
Simplicity Bancorp (SMPL) of Covina California started out as the in house credit union for employees of the Kaiser Foundation Hospital in 1953. It has since gone through several transformations and is currently a community bank with 9 branches in the greater Los Angeles area. Nonperforming assets are just 1.84% of total assets and they have plenty of capital with an equity to assets ratio of over 15%. The stock is trading at just 87% of tangible book value at the current price. The company pays a decent dividend of 2.1% and management is buying back stock in the open market.
Instead of worrying about trading results and investment banking revenues at giants like JP Morgan Chase (JPM) most investors would be better served looking for the little banks with strong balance sheets trading at a discount to their asset value.
As of this writing, Tim Melvin held long positions in ESSA and SMPL.