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The Mispricing Opportunity in Small Banks

By Motley Fool Staff – Mar 21, 2016 at 11:18AM

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There are thousands of small community and regional banks that investors tend to overlook, but these little institutions can offer big returns.

It's easy for investors to overlook the thousands of publicly traded small banks  found in every community across the U.S. They're tiny, under-the-radar institutions, quite different from the mega-banks that dominate the headlines in financial news. As a result, many investors fail to consider these companies' stocks, which can cost them access to some impressive returns.

In this segment from the Motley Fool's Industry Focus: Financials podcast, host Gaby Lapera and small bank guru Tim Hanson define exactly what constitutes a small bank stock, and discuss why investors should contemplate dipping their toes into the shallower side of the bank stock pond. 

A transcript follows the video.

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This podcast was recorded on March 14, 2016. 

Gaby Lapera: Today we are going to talk about bank stocks that we normally gloss over. Small banks, which the rumor is around the office that you are super into small banks.

Tim Hanson: I do love my tiny banks, yes.

Lapera: Let's start with a super basic question. What makes a bank a small bank?

Hanson: Its size. Its size is what makes it small. Generally speaking, small banks, community banks as they're widely known as, or regional banks, you're talking banks that have assets of ... certainly less than $10 billion in assets. And generally speaking, less than $1 billion is where it starts to get quite small -- but that's among the most fertile hunting grounds for interesting ideas in this space.

Lapera: Cool. I don't know, I think the smallest bank that we have talked about on the show might be Astoria Financial because they merged with New York Community Bank (NYCB -1.71%).

Hanson: Mm-hmm (affirmative).

Lapera: Other than that, I don't think we get much smaller than that.

Hanson: No, it's a pretty overlooked sector. That's why it's a good place for investors to go looking for ideas. You've got 50, 60, 70 people, hundreds of regulators, thousands of investors looking at things like J.P. Morgan and Wells Fargo every day. The opportunity to find a mispricing there is probably pretty remote, whereas if you're the only investor in something like Carter Bank & Trust  (CARE 0.48%) in rural Virginia or Suffolk Bancorp (SCNB) down on the east end of Long Island. If you're literally the only person looking at the numbers, then the opportunity to find a mispricing is that much more significant.

Lapera: Yeah, I feel like that's probably the greatest appeal of a small bank over a larger bank.

Hanson: I would say there are a couple points that make them more appealing to look at, certainly from an analyst stand point. Both a return and learning perspective. First, they're a lot more simple, they're a lot easier to understand. They don't have huge slush funds on their balance sheets that are just like "other" or "derivative contracts." Those are categories you have no idea [about] ... You look at some of those things, and there's notional value in the tens if not hundreds of billions of dollars on some of these bank balance sheets, and you don't know what's inside of it. Whereas small banks are a lot easier to read from a balance sheet perspective to see what they're doing with their assets and their liabilities.

Secondly, good luck getting Jamie Dimon or someone like that on the phone, whereas if you're looking at a community bank, particularly a bank in your community which is one of the best places to go looking for them, the opportunity to go in and talk to senior-level leadership, even if you're just an individual investor, is probably pretty good. There's no better way to get to know a management team than to actually get to know them over a cup of coffee.

Lapera: That is incredible. That is something that has never occurred to me, that is possible to do.

Hanson: Yeah, We're right here in Northern Virginia, and Northern Virginia is a pretty rich environment with regards to small banks. You've got Burke & Herbert (BHRB -0.13%) which is a big name in Alexandria. Access National (ANCX), there's Carter Bank & Trust, there are a number of the ... And literally, you can pick up the phone and call these folks and they'd be happy to talk to you, because they want to talk about their business. Like any entrepreneur, the guys that run these companies want to talk about their books and so on and so forth, and showing some interest in getting to know them is a great way to accomplish a bunch of things as an investor. A) Maybe get some return, and then B) become a better investor, learn about a company really from the bottom up.

Gaby Lapera has no position in any stocks mentioned. Tim Hanson has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short May 2016 $52 puts on Wells Fargo. 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.

Stocks Mentioned

New York Community Bancorp Stock Quote
New York Community Bancorp
$9.19 (-1.71%) $0.16
Suffolk Bancorp Stock Quote
Suffolk Bancorp
Access National Corporation Stock Quote
Access National Corporation
Carter Bank & Trust Stock Quote
Carter Bank & Trust
$18.63 (0.48%) $0.09
Burke & Herbert Bank Stock Quote
Burke & Herbert Bank
$71.25 (-0.13%) $0.09

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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