B. Riley on investing in small-cap banks: Selectivity is key
The credit crunch continues to take its toll on the economy, markets, and in particular, banking stocks. Analysts warn not to touch the Bank of America’s of the world, as there are only future write downs ahead. However, with little to no exposure to mortgage-backed securities, regional banks have cleaner and stronger balance sheets and may be overlooked long-term investment opportunities.
“If you’re patient and have the nerves to withstand the volatility of the market, I think you can get into the small-cap space, but you have to be highly selective,” said B. Riley senior banking analyst Andy Stapp. “There are banks whose assets will hold up well. That’s what happened in the last credit cycle, which was a real estate-related cycle.”
The top three qualities Stapp looks for when screening small-cap banks are markets, conservative management profile and the extent of the bank’s construction development portfolio.
“It starts by picking regional banks that operate in markets that have held up better than others,” said Stapp. “Pick banks that aren’t as vulnerable to the rise and real estate market.”
He says banks in California, Florida and Michigan have had a lot of exposure to real estate, as the value of real estate in those states has plummeted. However, there are other states in which the real estate market has better weathered the housing downturn.
“Texas is a much stronger market than the nation as a whole,” said Stapp. “The inventory supply levels are much lower [there]. The markets in the Philadelphia area and mid-Atlantic area have also held up much better.”
According to Stapp, the median value of single family homes in those markets actually rose 1% year-over-year in the fourth quarter, as contrasted with steep double-digit declines in markets like California, Florida and Michigan.
Some small-cap banks Stapp has “buy” ratings on include Bank of the Ozarks (Nasdaq:OZRK). The bank has one of the bigger construction development portfolios that has less perceived risk than its peers, according to Stapp. Additionally, the bank operates in markets that have held up better than others in the nation—Texas and Arkansas—where developers with high net worth are plunking down 30% to 40% equity into projects.
He also favors Pennsylvania-based Fulton Financial (Nasdaq:FULT) because he thinks it will wade this environment better, as evidenced by its performance during the last real estate crisis it in 1993.
Texas Capital (Nasdaq:TCBI) is another pick due to its lower risk profile. According to Stapp, the bank has historically had clean asset quality due in part to the Texas economy and the housing values. More than that, the small-cap bank’s strategy, in which it targets small-to medium-sized companies and their business owners, has served it well.
“It doesn’t cater to the mass retail market and it doesn’t have a financial network like the typical bank,” said Stapp.
However, not all small-cap banks are created equal. One area within small-cap banks Stapp cautions might not be worth the risk is start-ups. “Some of the consolidation in the startup banks are in peril for failure because they have to build critical mass and they tend to reach more aggressively,” he said. “They’ll take on riskier loans [and as a result] they have weaker asset quality issues than larger more established banks.”
Still, small-cap banks could stand to benefit. Coming out of the credit crisis, Ian Corydon, director of research at B. Riley says that some of the banks may be better off versus their competition if that competition has been weakened.
“Some of the big banks have been weakened more by what’s going now and some of these smaller banks that are more conservative and have better balance sheets might be poised to take back market share coming out of the crisis,” said Corydon.
“If you’re patient and have the nerves to withstand the volatility of the market, I think you can get into the small-cap space, but you have to be highly selective,” said B. Riley senior banking analyst Andy Stapp. “There are banks whose assets will hold up well. That’s what happened in the last credit cycle, which was a real estate-related cycle.”
The top three qualities Stapp looks for when screening small-cap banks are markets, conservative management profile and the extent of the bank’s construction development portfolio.
“It starts by picking regional banks that operate in markets that have held up better than others,” said Stapp. “Pick banks that aren’t as vulnerable to the rise and real estate market.”
He says banks in California, Florida and Michigan have had a lot of exposure to real estate, as the value of real estate in those states has plummeted. However, there are other states in which the real estate market has better weathered the housing downturn.
“Texas is a much stronger market than the nation as a whole,” said Stapp. “The inventory supply levels are much lower [there]. The markets in the Philadelphia area and mid-Atlantic area have also held up much better.”
According to Stapp, the median value of single family homes in those markets actually rose 1% year-over-year in the fourth quarter, as contrasted with steep double-digit declines in markets like California, Florida and Michigan.
Some small-cap banks Stapp has “buy” ratings on include Bank of the Ozarks (Nasdaq:OZRK). The bank has one of the bigger construction development portfolios that has less perceived risk than its peers, according to Stapp. Additionally, the bank operates in markets that have held up better than others in the nation—Texas and Arkansas—where developers with high net worth are plunking down 30% to 40% equity into projects.
He also favors Pennsylvania-based Fulton Financial (Nasdaq:FULT) because he thinks it will wade this environment better, as evidenced by its performance during the last real estate crisis it in 1993.
Texas Capital (Nasdaq:TCBI) is another pick due to its lower risk profile. According to Stapp, the bank has historically had clean asset quality due in part to the Texas economy and the housing values. More than that, the small-cap bank’s strategy, in which it targets small-to medium-sized companies and their business owners, has served it well.
“It doesn’t cater to the mass retail market and it doesn’t have a financial network like the typical bank,” said Stapp.
However, not all small-cap banks are created equal. One area within small-cap banks Stapp cautions might not be worth the risk is start-ups. “Some of the consolidation in the startup banks are in peril for failure because they have to build critical mass and they tend to reach more aggressively,” he said. “They’ll take on riskier loans [and as a result] they have weaker asset quality issues than larger more established banks.”
Still, small-cap banks could stand to benefit. Coming out of the credit crisis, Ian Corydon, director of research at B. Riley says that some of the banks may be better off versus their competition if that competition has been weakened.
“Some of the big banks have been weakened more by what’s going now and some of these smaller banks that are more conservative and have better balance sheets might be poised to take back market share coming out of the crisis,” said Corydon.
About the Author
Reporter Jennifer Schonberger is based in SmallCapInvestor.com's Washington, D.C. bureau.
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