"If only God would give me some clear sign! Like making a large deposit in my name at a Swiss bank."
-Woody Allen
Welcome to The Golden Sense! Everyone wants to fatten their bank account. Woody Allen found a way to do it and it sure wasn't a deposit from God. Yet, many of us take a different route in life as we aren't all actors and film directors. A good way to make your bank account grow is to invest your money. Investing is a challenge. From the outside the markets look rigged with the big money dictating the pace of the game. Companies on these crowded exchanges are having their earnings calculated and re-valued every second of the day by millions of investors using every metric possible. Large bank stocks are at the heart of this action. Banks are given special attention because these institutions earn substantial sums of money. Their business model generates huge revenues with loans and investments raking in the money day by day. Unfortunately, these stocks are saturated and it is no fun getting into a bidding war with a million other professionals who have insider knowledge. However, there is a way for the common investor to get a piece of the banking action. Like they say, when there is a crowd, try using the back door. Good investments can be made in small community bank stocks where the volume is thin and the growth potential is high.
The community banking sector is small but large enough where at least one exists in every county. Many of these banks are corporations that are traded on the OTC (over the counter) exchange. You can view the exchange on the link below:
Community banks are often ignored by investors simply because of their small size and a perceived lack of public information. For these exact same reasons, making a educated investment in these institutions can provide significant capital gains. Despite being over the counter stocks you can still purchase them through a common broker such as Morgan Stanley or TD Ameritrade.
In fact, getting the necessary financial information on these companies isn't as hard as it appears. You just have to know where the back door is.
The
information on all these banks can be obtained from the following website:
This website provides you with UBPR reports (Uniform Bank Performance Reports). These reports will give you all the metrics you would ever need on any bank of interest. The UBPR report provides you with the balance sheet, income statement, and financial ratios that can be compared on a quarter to quarter basis.
A stock price is basically the going rate for the current and assumed future earnings of a company. This makes it pretty cut and dry for the price movement of a community bank. By breaking it down to a few basic metrics it is easy to spot a community bank with good potential.
It's all about loans. Yes it's that simple. Community banks live and die by loan volume with many of these banks earning 90% of their income off traditional loans. All you have to do is track the loan volume of a bank. If the bank increases its loan volume on a quarter to quarter basis then it is likely to start reporting higher income levels. This of course will eventually translate into a higher stock price.
There are risks you have to be aware of. Increased lending is not a 100% guarantee that earnings will increase. There are always risks in banking such as loans that default, interest rate risk, economic disasters, and substantial expenditures that arise. By following a few basic metrics you can see if a bank will be able to survive and possibly thrive.
There are always going to be loans that default and these loans will eventually be charged off by the bank. Banks prepare for this by allocating a portion of their earning to "allowance for loan losses". In today's environment it is healthy to have over a 1.5% allowance for loan loss to total loans ratio. You can easily find this ratio on the UBPR report. It is difficult for an outsider to assess credit quality but knowing the bank has the ability absorb some losses is a sign of good management.
A
category to keep an eye on is loans on non-accrual status. Non-accrual loans are non-performing loans that are not
generating the stated interest rate because of non-payment from a borrower,
typically due to financial difficulties. Non-accrual loans are more likely to
default, meaning that the bank will not recoup their principal. Avoid
banks with any significant amount of non-accrual loans. Of course, this can be
found on the UBPR report as well.
By looking into the UBPR report you can view the balance sheet of the bank. On the balance sheet you will be able to see what type of loans the bank has. Like regular investors, a healthy bank has a diversified portfolio of loans. Beware of banks with huge concentrations in one particular loan type. This increases the risk that if a disaster hits the economy the bank could see heavy loan defaults in that one particular subcategory.
Finally, check the tier 1 capital ratio. The higher the ratio the more stable the bank is. The regulatory guidelines in the U.S. are minimum 5% tier 1 capital ratio. You want to invest in banks with ratios much higher than that. As an investor, think of the tier 1 capital ratio as the "oh shit" ratio. The tier 1 capital ratio is the core measure of a bank's financial strength. If the bank gets into serious financial problems it will need sufficient capital to see it through the hard times. If a bank fails, your stock will go to zero. Invest in banks with higher tier 1 capital ratios to give you the best chance this tragedy will never happen. In the community banking industry, there is no such thing as "too big to fail". If management messes up, the government is not going to come in and help these little institutions.
Most
community banks are priced somewhere between $5-20 a share. This makes them an
affordable investment. These stocks are thinly traded and many are completely ignored. This offers a great benefit to you as an investor. By tracking
the loan growth and keeping an eye on key ratios you can make an educated
investment with high potential for capital gains. Not only are these banks
constantly trying to grow, they are also ripe targets for acquisitions from
larger institutions. When a community bank is bought out by a bigger bank they
often get 1.5 times book value for the shares. That is when the shareholder
makes a killing on his or her investment.
The
opportunity is there. This is an investment practice that takes a little due
diligence but could offer better rewards than playing against the big boys on
the large exchanges.
Thomas Edison made a good point:
Thomas Edison made a good point:
"Opportunity
is missed by most people because it is dressed in overalls and looks like
work"
Signing
off for now,
T.
Norman
