Do Big Banks Care About You? This Company Doesn't Think So Either

Last November, StoneCastle Financial went public to little fanfare. The company, a closed end investment vehicle, raised a hair over $110 million to be used to invest into U.S. community banks. 

As of yet, the company hasn't reported any quarterly financial information, and it will be some time before management is able to fully deploy this capital. So while I'm hesitant to invest in StoneCastle today, I am absolutely excited about what this vehicle represents. Here's why.

Bank of America and other mega banks are bullies
The concentration of assets in the U.S. banking industry is mind blowing. Its the root cause of "too big to fail." It's a driving reason why a handful of banks can pump and then dump the U.S. economy with sub-prime loans, and its the reason that the country can lose $14 trillion of wealth in a two year span without any meaningful repercussions for those responsible.

What StoneCastle represents is an opportunity for investors to gain exposure into community banks across the country. Banks without "too big to fail," without major proprietary trading desks, without expansive derivatives contracts.

A loan at Bank of America (BAC 0.45%) is likely approved by either a computer algorithm or a bureaucrat hundreds of miles away in Charlotte. A loan at a typical community bank is approved by a local banker, a human being who knows you, knows your community, who actually understands your character. And character is the most critical assessment in predicting repayment.

The investment opportunity in community banks
Some of you may be thinking, "But can't I just buy an index fund and accomplish the same thing?" Yes, and no.

Index funds are great, particularly the low cost variety. However, there are advantages to a specialized company selecting bank stocks rather than relying on the broad strokes of an index fund. 

Take activist investing legend Carl Icahn as an example. Over his career, Icahn has time and again invested huge stakes in companies to gain direct and specific influence on the business. This influence is critical. Because of his out-sized and active ownership, Icahn can implement tangible changes to the business or capital structure to increase shareholder value.

The performance of his Icahn Enterprises L.P. (IEP -0.29%) serves as evidence enough. Per Ichan, an investment in Icahn Enterprises at the end of the recession would have returned nearly 350% as of the September 30, 2013 quarter end. 

Icahn says that:

Most importantly to current IEP unit holders is that in my opinion there has never been a better time than today for activist investing, if practiced properly. Several factors are responsible for this: 1) extremely low interest rates, which make acquisitions much less costly and therefore much more attractive, and 2) the current awareness by many institutional investors that the prevalence of mediocre top management and non-caring boards at many of America's companies must be dealt with if we are ever going to end high unemployment and be able to compete in world markets. I believe that the greatly increasing need for a catalyst to make acquisitions possible and to make mediocre managements accountable will be of meaningful benefit to IEP in future years.

StoneCastle may not have an activist philosophy quite like Icahn, but the company does have advantages over simple common stock investments of the typical retail investor or an index fund.

Yes, the company will be taking positions via common stock, but investments will not be limited to this security alone. Expect to see investments via preferred equity positions, subordinated debt, or hybrid structures. These are structures not generally available to individuals like you or me. 

The aim of these investments, per StoneCastle is two fold. First is current income (read as "dividends"), and second is capital appreciation.  For long-term investors, both of these objectives are spot on and fit with the preferred, common, and subordinated investment structures. 

To accomplish these objectives, StoneCastle will take long-term positions in banks with bright futures. Banks where an improved capital structure can provide the foundation for consistent dividends, steady stock price increases, and sustainable growth over the very long term. Its a very Foolish approach indeed.

StoneCastle has only been public for about six weeks and has not yet filed a full public report with the SEC. That will happen for the quarter ended December 31. Moody's has rated the company on a pro forma basis and awarded a credit rating of A3. That's reason for optimism.

For investors, it may be too early to invest in StoneCastle. But for those interested in banks without the baggage of "too big to fail," StoneCastle is worth adding to your watch list.

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