All Banks Are Not the Same

The Federal Reserve and other bank regulators like banks of a certain size.  They hate really big banks, because they are so big they tend to extend themselves into bizarre, risky and uncertain products.  For the really big banks, ordinary commercial lending does not feed the bulldog, they search for gimmicks (like sub-prime lending, etc.)  Really small banks aren’t quite so bad, but the Fed tends to like banks over $100-200 million market cap because they tend to have some diversification.  Banks in the single $ billion market cap are cool with them too.


Now these are two polar opposites.  The biggest banks are much, much scarier.  The tiny banks, however, are even more likely to go broke on a regular basis simply because they are dependent on a small geographic area and somewhat more likely to take a “relatively” large risk on some silly local idea.  When I was in High School, one of the two local banks in our community got very promotional about a museum concept.  It was something like an American Motor Sports Museum.  We had a very large empty factory in the community and we had a close relationship with Gordon Johncock, who liked to refer to our town as his “home town” even though it wasn’t.  Johncock was a big deal in Indy-style racing back then.  He was a two time Indy winner.


All well and good, but the bank spent some serious money on this and it didn’t work out.  It didn’t bankrupt the bank, but it hurt it badly and it took many years to dig itself out of the loss.  That’s the kind of risk that small banks can suffer.  The Fed likes more regional banks.  These are not locked into too small an area, less likely to marry a stupid idea or local fad.


On top of this, there is the law of economies of scale.  Bigger is always better for one reason or other, and with banks much of this is a function of the cost of regulation.  I almost hesitate to call it regulation, because that’s rather a term of disdain.  I’d rather say it’s a function of Fed and other oversight trying to make sure you aren’t doing something stupid that will put your depositor’s money at risk……  Yeah, that’s right; banks do stupid stuff sometimes even when their reputation is for stuffed shirt conservatism.


Now, all that said some bankers are pretty sharp people.  I watched a guy running a small, converted Savings & Loan quadruple investors money in under five years and sell out to a bigger bank.  Quadruple!!!  Quadruple!!!  There are always guys willing to start little banks, even though you would think the economies of scale are so stacked against them.  If they run clean and smart, they and their investors can do very, very well.


As I’ve mentioned before and alluded to here, one of the endpoints for small and medium sized bank investing is that you get bought out by a bigger bank.  It’s always a possibility.  In some sense, bankers are always hoping to position themselves to attack a higher book value (BV) multiple, and THEN be taken over at an even higher multiple.  Let’s say I run a bank smartly and move my BV multiple from 0.9 to 1.2 in two years.   I must have also growth earnings to do that, so I’ve basically moved the stock up about 50%, not just 33% that the BV move would imply.  Now let’s say that they operate smartly for another couple years, growing earning and book value, and my stock moves up another 20%.  That’s about 80% from my starting point, and then I sell out at 1.7 times book.  That’s about a 250% return or about 64% per year.  Not chicken feed.  Even if you don’t get that much, move all my numbers down 10%, you still look at 40% per year!  Come on………….


And this is exactly the environment for this kind of action.  BV ratios have already started to move.  The changes to interest rates ALONE mean almost every banks will be reporting better earnings.  Plus, the economic juices (potential fiscal spending) meaning businesses FEEL more confident and want to borrow and banks want to lend.  In short order, both earnings and BV ratios grow.  It’s easy to see a 20%, 30% or even more move in small/medium banks stocks over the next year or so.  For small banks, this can be bigger IF they are starting from a lower than normal BV and expand that.  For some not-quite-so-small-banks, it could be their SELL OUT POINT —-another final boost of 40 or 50%.


Here’s another thing to think about: little banks overall tend to be recession-resistant.  First, they never get genuinely expensive (something that happens to larger banks with big institutional ownership.)  Sure, they can get fully priced and go down a little in a recession, but they fiercely try to protect their dividends and this very often provides a cushion:  A stock that is already yielding 4% for example, drops by 20% and suddenly has a 5% dividend.  New investors look at that dividend.  Now let’s say that over a couple/three years, your little bank stock doubled, DOUBLED!, is a drop of 20% that bad?


Your high tech stock might drop by 30, 40% or more.  Your “nice” stock that went up 40% over two/three years, which is a nice return, loses it all and you’re back to even.  This is a sweet spots for little banks.  It’s where “local” helps growth.  Local businesses KNOW the executives of the banks and they like dealing local.  Suddenly Main Street does better than Wall Street, and little banks are growth vehicles while still being fairly conservative.


A lot of recessions are “Wall Street Recessions.”  They hit the S&P worse than they hit Main Street.  Sure, recessions are always bad.  People losing jobs is always a bad thing, but often Wall Street’s reaction is worse than the job loss.  Don’t look at 2007-2008 as an example; that was a economic collapse caused by the BIG BANKS, not an ordinary recession.    In ordinary recessions, little banks hold up well.



PS – Some follow through on gold.  Pretty strong rally after the short covering, actually, and accompanied by strong reversal of dollar strength and lower long Treasury rates today.  Silver stocks much stronger than gold BTY.  Worth watching.  That is all.