Thursday, June 13, 2013

Analyzing And Investing In Community Banks

When the stocks in your universe are no longer as undervalued as they used to be, you *could* lower your standards and keep investing. Alternatively, you could expand your universe. That's what I'm trying to do, as I dip my foot into the financials pool. Reading David Moore's book, Analyzing and Investing in Community Banks, was a helpful step in this process.

The national banks are intimidating. They hold various derivatives and other securities that are difficult to understand. Their financials represent consolidations of all sorts of different operating entities, making risk assessment very difficult.

But the good news is that this is not the norm for banks in the US. Community banks are much simpler institutions, and there are thousands of them, many of which are public. Moore guides the reader through a community bank's balance sheet and income statement, pointing out where the differences between banks lie and where the risk comes from. If you can understand the risks, you are in a position to value the company.

While Moore did hint at being a value investor to some extent, the book is aimed at a larger audience. So while it offers a great deal of information on understanding banks, it doesn't go into great detail on low multiple investing. But there are other value investors out there who do invest in this sector. One in particular who I read is Nate at He offers a great introduction to bank investing from a value perspective, which I believe you'll get more out of once you have read Moore's book.

(Incidentally, though Amazon shows the book as unavailable, rumour has it that a pdf copy may be floating around the web...but you didn't hear it from me!)

Disclosure: I don't own any financials...yet


Sidekick said...

I find it hard to get interested in investing in banks. Their book value is usually tied up as regulatory capital, which is increasingly stringent and not really worth much to the investor.

So to me they are only really worth the free cash they are generating, and it's rare the market undervalues this currently.

I actually did a post about this on my blog not long ago, I'd been looking at a few community banks I found on other blogs, but always had the same feelings towards them.

Nate Tobik said...


I read your blogpost and I disagree with your position on banks. Let me explain.

You write off banks because their equity is regulatory capital, which is unlikely to be distributed. But that's no different than any business where equity consists of hard assets. A real estate company is unlikely to distribute their RE holdings to equity investors. A manufacturing company's assets have value, but they won't be distributed.

With your definition the only equity that has value is pure cash, maybe a SPAC or something similar.

The reality is equity capital in a bank is very liquid, it's cash and marketable securities. It's not an old warehouse or unsalable real estate. If a bank were to pay back all depositors and sell off all loans to a different bank equity investors would receive about 90-95% of equity (not 100% due to the cost incurred to wind down).

There are few if any other businesses in the investing space where if liabilities were settled with assets investors could receive book value so quickly.

I'm not sure if you've looked at many bank deals, but even banks trading at 1/2 of BV can sell their loans at par. It's very unusual to see a loan book go for something less than par unless there are some bad credits. Usually though the acquirer will only buy the good credits and pay par, maybe 3% under.

Additionally banks are easy to sell. A non-bank corporation usually has a uniqueness to them, and in some markets few competitors. This means there are few acquirers. Banks are different, they are the ultimate commodity business with a moat (paradox, isn't it?). A bank can sell to a bank down the street with ease. It's rare to see a bank trying to sell itself with no bidders, unless their credits are terrible. But even terrible credits have buyers.

Sorry for the long comment, I feel that maybe you haven't spent enough time in the sector. You made a few stereotypes and brushed it all off. I'd encourage you to investigate further, there is a lot of value in the banking sector.


bovinebear said...

Well, if I may chime in, the problem with banks that I see is they borrow short and lend long, that is great in an environment of falling rates. That is why I think their results look so good recently. But when rates rise their numbers won't look so great anymore.