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What's Happening to the Smaller Banks?
Posted by: Tim Melvin (IP Logged)
Date: October 15, 2013 09:52PM
Consider the life of a banker running a small bank today.
It used to be a great life running one of these little banks. You oversaw a network of 10 or 15 branches in smaller towns or suburbs across the country and were a well-liked business leader of your community.
More than likely you weren't just a member of the Rotary and other civic groups, you were an officer of the group.
Bankers helped people buy homes, grow their businesses, put their kids through college and even save for and fund their retirement. The employees had good jobs and made decent money and really liked the bank and the officers. The stock price was at a nice premium from the original offering price and most folks in town were pretty excited about that. On weekends, the bankers probably played golf and went to local college games with local politicians, developers and car dealers.
It was a good, some might say, wonderful life
That has changed just a smidgen over the past few years for many of the community bankers. In the wake of the credit crisis, bankers have had to foreclose on people they formerly played with on the high school baseball team. At least two of the golfing buddies have gone out of business because the bank was unable to roll over their line of credit.
Thanks to the new tough lending standards put in place to protect what was left of the balance sheet when real estate prices collapsed, banks turn down most loans these days. The loan officers spend most of their time playing solitaire and circulating their resume on Monster (MWW) or updating their LinkedIn (LNKD) profile.
Business Is awful
Loan demand is down, net interest margins have collapsed thanks to the Feds ongoing zero interest rate policy (ZIRP). Deposit money is walking out the door to the local brokerage offices and insurance agents in search of a return higher than the 1.25 percent smaller banks can pay on a one year C/D. The in-house attorney has advised you that thanks to the new regulations, banks will have to add staff (and costs) to the legal department just to keep up with the flood of new rules and regulations.
The regulators have been frequent visitors digging thought the financials and just generally making life difficult. The stock price has collapsed and now everyone is sitting on big losses and more than a little angry that the bank had to cut the dividend to meet capital requirements. The handicap has gone up 10 stocks in the past couple of years because unless banks have friends in from out of town, they cannot find three people willing to play golf with a banker.
Life Is No Longer So Wonderful
Now step back and take a look at the bigger picture for regional and community banks. Everyone has the same problems with loan demand and low net interest margins. The regulatory costs are rising for everyone. The weak economy makes growth difficult and there is already a bank branch on every corner of every major intersection across the country.
While the number of banks has shrunk, the number of bank branches has soared from 73,000 in 2000 to almost 90,000 now. Organic growth of the deposit base and loan portfolio is almost impossible. Growing the footprint by opening new branches makes no sense whatsoever. There is only one way to grow and that is by acquiring or merging with other smaller or similar sized institutions in your region.
The executives in the corner offices of the larger community banks and smaller regional institutions are well aware that they have to grow their deposits to spread the new regulatory and compliance costs. Smaller banks need to grow earnings to keep the stock price up and keep stock holders happy.
The only way to grow is to buy other banks and expand the footprint and customer base of your bank. The smaller bank has its guys working around the clock, crunching numbers and comparing branch networks looking for smaller banks that fit your purposes.
Back to the small bank banker that finds himself in a heated discussion with his attorneys. It seems some folks in places like Chicago, New Jersey and Florida have all purchased more than 5 percent of the share and filed 13D forms with the Securities and Exchange Commission.
The smaller bank has received a very nice letter informing it that at 80 percent of tangible book value, the stock is too cheap and they must do whatever it takes to improve the value of the stock. It is politely stated that the small bank officer is an incompetent manager of the bank and should consider retiring for the greater good of the bank.
Retiring Sounds Nice at This Point
What was a great career has turned into a frustrating, maddening series of impossible challenges and hurdles. Unfortunately most of the net worth is the nest egg of most of the other officers and directors of Anytown Bank. All would love to walk away at this point, but the stock price is just too cheap to cash in and move on to another career or retirement.
The phone rings at that moment and it is the CEO of Almost Regional Bancshares. He has studied the matter and thinks your network of branches and local business customer base would be an excellent fit for his plans to grow the bank into a serious regional competitor. Furthermore, after studying the assets and loan portfolio, the small bank officer is so convinced that Anytown Bank is a great fit he is willing to pay you a substantial premium over the current discounted value of your shares. How do you think our friend will respond to this offer?
This scenario is playing out all over the U.S. and will continue to do so for most of the next decade. Organic growth is next to impossible and the path to profits lies in mergers and acquisition. Bankers at small and mid-sized banks all over the country are going to be getting these phone calls and many of them are going to be open to selling.
Buying small banks at a discount to the tangible book value of the shares is truly going to be the Trade of the Decade.
Tim Melvin is a value investor, money manager and writer. He has spent the last 27 years as in the financial services and investment industry as a broker, adviser and portfolio manager. He has also written and lectured extensively on the markets with his work appearing on RealMoney.com, DailySpecualtion.Com as well as several print publication including Active Trader and the Wall Street Digest. Click to watch Tim Melvin's FREE webinar and learn how to break through volatility using his value stock strategy.
Stocks Discussed: LNKD, MWW,