Lately, small regional and community bank stocks have been written on as the ‘Trade of the Decade. ‘
In the aftermath of the real estate and credit crisis, bank stocks collapsed in value and many of the smaller ones were valued at a fraction of their tangible book value. As regulators rushed to close the barn door (after the horse got out), the costs have jumped dramatically and it is difficult of these banks to deal with the costs of challenges of staying in compliance with alphabet soup of regulations.
In addition, it is virtually impossible for small banks to grow earnings in an over-banked world with anemic economic activity. The only way to grow is to buy another bank. This also helps spread compliance costs out over a large base of assets and deposits.
The stage is set for a huge merger and consolidation wave in the regional and community banks. It costs too much to go it alone and it is almost impossible to grow profits at a rate that will appease shareholders. Activist investors have noticed the deep under valuations in the sector and have entered the banking sector in unprecedented numbers.
The stocks are cheap and economic and regulatory climate is almost forcing many of these banks to put themselves up for sale. In a recent survey, 64 percent of small bank CEOs said they expect to be involved in M&A activity in 2014.
Given these conditions, it was no surprise Thursday to see that Jefferson Bancshares (NASDAQ: JFBI) is being acquired by HomeTrust Bancshares (NASDAQ: HTBI). HomeTrust is based in Western North Carolina and this allows them to expand into Tennessee at a bargain price and add more than $500 million in assets to their portfolio.
Jefferson Bancshares is typical of the type of bank that should have been bought as part of the trade of the decade portfolio. The bank has 10 branches and two limited service locations with more than $500 million in assets. The service area is primary market areas to consist of Hamblen County, Knoxville, Johnson City and Kingsport, Tennessee, and the Virginia tri-cites region. Officers and directors owned a little over 12 percent of the bank’s shares and the ESOP owned an additional 9.5 percent.
The bank had struggled a little with its loan portfolio during the crisis and nonperforming assets peaked out at almost five percent of total assets in 2012. Management has worked steadily to improve the quality of the loan portfolio and current nonperforming assets are down to just 3.05 percent.
Initial consideration for the stock came when NPAs were about 3.81 percent of total assets but had been declining steadily. Equity was continually over the 10 percent of assets level that would’ve been preferred, so the bank was considered more than adequately capitalized. This was a basic little bank with management dealing with its problems successfully and the stock was trading at just 70 percent tangible book value.
This in and of itself was enough to consider buying shares of Jefferson. However as a bonus long time bank stock activist Joseph Stilwell had purchased more than six percent of the stock and had filed a 13D, disclosing, “We intend to seek board representation at next year’s annual shareholder meeting if the Issuer has not announced its sale. Our purpose in acquiring shares of Common Stock of the Issuer is to profit from the appreciation in the market price of the shares of Common Stock through asserting shareholder rights. We do not believe the value of the Issuer’s assets is adequately reflected in the current market price of the Issuer’s Common Stock. We hope to work with management and the board of directors to maximize shareholder value.” Luckily, there was a good bank and a great price and an activist investor to act as a catalyst for change.
This made buying the stock the equivalent of an uncontested layup in my eyes and I started buying back in June around $5.50 a share. The takeover will give me a total gain of about 45 percent when the deal closes.
That’s the second notable small bank takeover in the past six months. Huntington Bancshares (NASDAQ: HBAN) made a deal to buy Cameco Financial (NASDAQ: CAFI) and netted a 72 percent gain. There are another hundred or so small banks that could fall within these buying parameters if there’s a decent pullback in the overall market or the financial sector.
The ‘Trade of the Decade’ in small banks is going to make astute investors an enormous amount of money over the next decade.
(c) 2014 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
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