Following the financial crisis, many investors turned away from bank investing forever. That left many banks to trade cheaply, with a large number selling at low historical multiples of book value.
Top performers haven't followed the rest of the industry, however. Two of the most expensive regional banks on the market today trade at high multiples, but even at above-average prices they may be among the most interesting options to be found.
An isle of profits
Bank of Hawaii (NYSE:BOH) is one of the most interesting cases in banking. In its core geography -- you guessed it, Hawaii -- it is part of a powerful duopoly. First Hawaiian Bank and Bank of Hawaii control 67% of deposits in the state.
Outside the top five banks in Hawaii, the remainder control no more than 2% of deposits. This is completely counter to the industry on the mainland, where thousands of banks compete for a small share of a geographically dominated banking business.
Competitive dynamics aren't all that set it apart. The balance sheet looks nothing like most banks. Bank of Hawaii has prioritized investment securities (government and corporate bonds) over loans and leases. This mix naturally carries much less credit risk than your average bank.
You'd expect that with roughly half of the bank's assets in securities, which generate lower yields than a directly originated loan book, it would perform rather poorly. But it hasn't. In most columns, Bank of Hawaii performs near the top of the pack, earning double-digit returns on equity in each of the last 10 years. Prior to the financial crisis, returns on equity were in excess of 25% for five years running.
The bank's low efficiency ratio, which has most recently centered around 60%, helps support above-average returns despite its large investments in securities.
The only downside with Bank of Hawaii is that it's rare to get shares cheap. The company currently trades for roughly 2.6 times tangible book value, according to S&P Capital IQ. One reason for the high share price is the company's efforts to return almost all earnings to its investors via dividends and share repurchases. In the last 10 years, diluted share count has fallen by 21% to 44 million shares outstanding.
Should rates rise, a corresponding increase in the bank's net interest margin might make the sky-high price tag a little more attractive. Keep this one on your watchlist.
A bank on the "middle coast"
Smack dab in the middle of flyover country is a bank most would love to imitate: Bank of the Ozarks (NASDAQ:OZRK). Whereas Bank of Hawaii has grown largely organically in its home market, Bank of the Ozarks is a serial acquirer, wrapping small banks under its umbrella at any chance it gets.
The bank's high valuation at 3.4 times tangible book value explains some of its rationale for growth. Bank of the Ozarks can trade its stock to acquire lower-priced rivals, pushing down its current valuation. In a recent all-stock deal, Bank of the Ozarks acquired Intervest National Bank at 1.1 times tangible book value, a bargain relative to its own high-flying stock price.
This isn't a one-trick pony, however. Acquisitions only explain part of its top performance. Longtime CEO George Gleason has also navigated the bank toward more lucrative lending opportunities.
The company's geographic exposure gives it an advantage over most other banks. Bank of the Ozarks reports that nearly half of its loan book is attributed to Texas, a state with low employment and high demand for commercial loans in booming businesses such as oil and gas. Higher-yielding, nonfarm, nonresidential loans make up the bulk of loans on its balance sheet.
Naturally, one might expect that a high-yield loan book could create trouble in economic downturns. Over history, this hasn't been the case with Bank of the Ozarks. Charge-offs topped 1% in only one year in the last 15 years (2009). And during the same 15-year period, expenses have largely remained under half of the company's top-line revenue. Efficiency plus good underwriting lead to excellent performance for any bank.
No matter how well run it may be, a price of 3.4 times tangible book value, according to S&P Capital IQ, makes this bank best suited for your watchlist. Investors are seemingly pricing in continued accretive acquisition activity for years to come. A surprisingly poor quarter or a slowdown in acquisitions could lead to a lower price at which investors can be comfortable buying and holding shares forever.
Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of Bank of Hawaii. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.