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Tim Melvin
Articles (32) 

Small Bank Earnings Are Here: What to Watch

The community bank portfolio continues to outperform, and we should see a lot of M&A in the portfolio next year

February 02, 2016 | About:

The earnings for our small banks stocks are starting to come in this week, and the most used phrase I am seeing is “record earnings.”

Several of our stocks are hitting new high prices as the positive earnings, dividends and buyback news hit the tape. The really nice part here is that they are still cheap and have a long way to go. Some of our names are just liquid enough to attract the attention of smaller momentum players so the good times could continue for a few weeks.

We have more earnings next week so even though I am heading to Phoenix for the weekend I am thinking of New Orleans and its unofficial slogan of “Laissez les bon temps roule.” The good times continue to roll on for small bank stock investors.

In Phoenix I will be attending the Bank Directors Magazine Acquire or Be Acquired conference. Over 600 bankers will be in attendance along with bank stock investors, fintech companies and other folk related to the banking industry.

2015 was a good year for bank mergers, and 2016 should continue and perhaps strengthen that trend. SNL Financial staff writers Mohsin Azam and Nathan Stovall recently opined that “Bank observers believe the drivers of M&A remain intact as the industry faces continued profitability pressures from prolonged low interest rates, necessary technology investments and costly compliance with regulation. Banks are also not expected to receive the same boost from reserve releases as they have in years past.”

Al Dominick of Bank Director wrote this week that much of the activity will be in the smallest of banks. He wrote that "When people tell you that size doesn’t matter, realize that banks with less than $500 million in assets have had the lowest return on equity for 11 out of the past 12 quarters (per SNL). Expect even more sellers to emerge from this part of the industry. As the regulatory environment becomes increasingly difficult to maneuver, it is safe to anticipate an increase in merger activity — mostly for banks with less than $50 billion of assets."

However he added that we may see some bigger banks return to the game, noting that “As evidenced by Huntington Bancshares Incorporated (HBAN) announcing today that it would buy FirstMerit Corp. (FMER) in a deal worth $3.4 billion in stock and cash, mergers are a viable option for growth among the larger regionals. While we don’t have the same kinds of national consolidators buying up banks like they once did, deals like this one, KeyCorp (KEY) announcing it would buy First Niagara Financial Group Inc. (FNFG) and New York Community Bancorp that it would buy Astoria Financial at least opens the possibilities of larger players getting back in the merger game.”

We live in the smaller bank space but are not opposed to adding larger banks, particularly in the Deep Value Portfolios if they fit our metrics. In the bank portfolios our average market cap is below $50 million, and we have been adding some of the teeny tiny banks to what I call our bonus bank portfolio. These are so small it is no guarantee that everyone can buy them, and our own buying could temporarily give a positive skew to our portfolio performance so for reasons of fairness and integrity we label them bonus picks. Our latest bonus pick trades less than 200 shares a day so it can be hard to buy, but it trades at 85% of book value with a strong balance sheet and solid loan portfolio with three potential bank stock activist investors as shareholders.

The 5%-plus bounce in oil has been friendly to our energy positions, and we are seeing some really nice rebounds in these names at long last. We have three energy-related positions up over 20% in the last week, and all that green is a huge improvement from a holding sheet that looked like someone had sliced a vein over the pages to make it run red. We have a ways to go for these stocks to move fully back into the black, and the only thing I will predict about oil prices is continued volatility, but I will enjoy it while I can.

We continue to hold a lot of cash in our deep value portfolios. Even with the volatility and about a 10% decline in the Standard & Poor's 500 to start the year, we have not seen a lot of value creation so far. Much is made of the fact that we have pulled back about 25% in the Russell 2000 but keep in mind that the index had quadrupled before topping out at around 120 last year. I like the current 100 price in the ITM, but we are still way above the 30 level where we bottomed in 2009.

Since then sales growth has not been all that robust, and we have seen a lot of the same financial engineering and cost-cutting moves drive profit gains since then. It is not cheap either as the index is trading for almost 20 times expected earnings, according to a recent Morningstar Report. The broader market is cheaper than it was, but it is not really cheap on an absolute basis just yet.

The good news is that it is only 20 days until pitchers and catchers report. I am pretty excited to get things under way and already have my Orioles-Braves tickets for March 1 at Disney ESPN Wild World of Sports here in town. I like the Orioles' chance this year especially if some of our young pitchers perform well and the top tier arms in AA and AAA can move up to the bigs. My son-in-law has Cubs tickets so I look forward to some afternoons in the Windy City kicking back with an Old Style or three taking in some National League games as well this year.

We have our energy stocks, some special situations, a lot of cash in the deep value mix. The community bank portfolio continues to outperform, and we should see a lot of M&A in the portfolio next year. I like the way we look as the first month of 2016 comes to a close.

Have a great week everyone.


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