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It is probably fair to say that regional banks rely heavily upon the yield curve or, more specifically the slope of that curve. The slope determines the spread, or difference in rates that banks can charge for loans vs. the rate on deposits they must pay to fuel the lending. This is also known as NIM (Net Interest Margin), in some ways the Gross Margin for banks.
The yield curve is a bit of shackle on demand for banking products and can tempt the typically conservative operators of regional banks to venture into more speculative endeavors for the sake of growth. Historically, this has involved sub-prime lending, lending to high growth industries like oil and gas fracking, or lending to hot real estate markets. And history shows this can sometimes end very badly, a kind of “stick to your knitting” lesson. Developing wealth management services is probably a safer avenue for growth.
That being said, regional banks can reduce interest rate sensitivity, through acquisitions, or taking market share in geographies with positive economic and population characteristics which can boost lending and deposits. Thus, the volume of product can increase which can be leveraged. Here we highlight two microcap regional bank stocks that we believe meet these characteristics.
The first microcap bank is BV Financial Inc. (BVFL - Free Report) based in Baltimore. The company completed the second step in its demutualization process at $10/share in July of 2023, raising net proceeds of $86.9 m. Demutualization’s tend to price below Book Value in order to attract investor interest, so they’re generally ideal from a valuation standpoint to begin your investment. Some academic evidence supports that demutualization’s tend to outperform because of this initial discount in valuation. BV Financial Inc has been an acquirer, so the new dry powder helps with this strategy.
The bank lends into the Delmarva (Delaware and parts of Eastern shores of Maryland and Virginia) Peninsula. This region is known for warmer weather, lakes and beaches, and lower taxes. The population of Sussex County, Delaware’s second most populated county, grew at a near 2% CAGR from 2010 to 2020, a fertile breeding ground for deposits.
BVFL is trading at about a 30% discount to book value of $17.50 and a 22% discount to tangible book value of $16.10/share. About 50% of its loan portfolio is commercial real estate without a disclosure of office real estate. Recall that in addition to office space commercial real estate typically consists of warehouses, storage rentals, retail space, hotels, manufacturing facilities, etc.
If we assume half of the commercial loan portfolio is office, which I think is high, then 25% of the overall portfolio would have exposure. If we further assume a worst-case scenario of a 50% impairment haircut to these loan values, the stock would require a 12.5% discount to book value (.5*.5*.5). This compares to the current 30% discount suggesting a possible valuation disconnect. Also note that a competitor in the region, Partners Bancorp Inc., was taken out at 1.2x Book Value and 1.3x Tangible Book Value last December.
Image Source: Zacks Investment Research
Concern around regional bank exposure to commercial office real estate given the WFH (work from home) phenomenon is rightly justified. It seems the consensus regarding this potential fall-out is that it is more likely to follow the cadence of a slow bleed (periodic write-offs based on market) vs. a panic driven, widespread systemic shock like the Great Financial Crisis.
If you’d prefer to avoid office exposure more completely than perhaps Cullman Bancorp Inc. (CULL - Free Report) is a better fit. As of 12/22’s 10K we calculate the office loan exposure to be about 5% of the loan portfolio. The county of Cullman in Alabama is located about 50 miles north of Birmingham and led all 67 counties in industrial expansion and overall industrial projects in 2019. The population grew 1.14% last year and 15.29% since the last census of 2010. From 2010-2020 the county was the 9th fastest grower of the 67 counties.
The stock trades at about a 23% discount to Book Value of $14.48 and 16.5% to Tangible Book Value of $12.59/share. Trading liquidity in the stock is a risk factor so no market orders please.
Image Source: Zacks Investment Research
The graph below of the S&P regional bank ETF shows that while regional bank stocks have bounced back lately, they remain markedly lower than early 2022 levels. I won’t opine on the timing and duration of possible interest rate cuts. But my gut tells me inflation may prove stickier than expected due to three compelling structural forces in the economy which are inherently inflationary: labor shortage with wage inflation (barring major immigration reform), onshoring, and elevated fiscal spending. It seems that now we could have to live with comparatively higher rates than what we’ve been used to for many years. AI may enhance labor productivity and help blunt some of these forces but this may take a while to play out.
Image Source: Zacks Investment Research
My other opinion is that the mortgage market, which is an integral business for these banks, is relatively stable. This market has withstood interest rate hikes due to a chronic housing supply issue which will most likely continue barring any major NIMBY (Not In My Back Yard) reforms. And post financial crisis bank reforms appear to have reined in risky mortgage lending.
While these two stocks are arguably not multi-baggers anytime soon, they could offer a measured way to gain financials exposure within a portfolio. Both banks are profitable and trading at discounts to Book Value. Finding lesser-known pockets of population and economic growth within certain regions coupled with a compelling valuation can lead to regional bank outperformance. And discovery of this type of asymmetric information is often how microcap stocks outperform.
Image: Bigstock
Which Microcap Can You "Bank" On?
It is probably fair to say that regional banks rely heavily upon the yield curve or, more specifically the slope of that curve. The slope determines the spread, or difference in rates that banks can charge for loans vs. the rate on deposits they must pay to fuel the lending. This is also known as NIM (Net Interest Margin), in some ways the Gross Margin for banks.
The yield curve is a bit of shackle on demand for banking products and can tempt the typically conservative operators of regional banks to venture into more speculative endeavors for the sake of growth. Historically, this has involved sub-prime lending, lending to high growth industries like oil and gas fracking, or lending to hot real estate markets. And history shows this can sometimes end very badly, a kind of “stick to your knitting” lesson. Developing wealth management services is probably a safer avenue for growth.
That being said, regional banks can reduce interest rate sensitivity, through acquisitions, or taking market share in geographies with positive economic and population characteristics which can boost lending and deposits. Thus, the volume of product can increase which can be leveraged. Here we highlight two microcap regional bank stocks that we believe meet these characteristics.
The first microcap bank is BV Financial Inc. (BVFL - Free Report) based in Baltimore. The company completed the second step in its demutualization process at $10/share in July of 2023, raising net proceeds of $86.9 m. Demutualization’s tend to price below Book Value in order to attract investor interest, so they’re generally ideal from a valuation standpoint to begin your investment. Some academic evidence supports that demutualization’s tend to outperform because of this initial discount in valuation. BV Financial Inc has been an acquirer, so the new dry powder helps with this strategy.
The bank lends into the Delmarva (Delaware and parts of Eastern shores of Maryland and Virginia) Peninsula. This region is known for warmer weather, lakes and beaches, and lower taxes. The population of Sussex County, Delaware’s second most populated county, grew at a near 2% CAGR from 2010 to 2020, a fertile breeding ground for deposits.
BVFL is trading at about a 30% discount to book value of $17.50 and a 22% discount to tangible book value of $16.10/share. About 50% of its loan portfolio is commercial real estate without a disclosure of office real estate. Recall that in addition to office space commercial real estate typically consists of warehouses, storage rentals, retail space, hotels, manufacturing facilities, etc.
If we assume half of the commercial loan portfolio is office, which I think is high, then 25% of the overall portfolio would have exposure. If we further assume a worst-case scenario of a 50% impairment haircut to these loan values, the stock would require a 12.5% discount to book value (.5*.5*.5). This compares to the current 30% discount suggesting a possible valuation disconnect. Also note that a competitor in the region, Partners Bancorp Inc., was taken out at 1.2x Book Value and 1.3x Tangible Book Value last December.
Image Source: Zacks Investment Research
Concern around regional bank exposure to commercial office real estate given the WFH (work from home) phenomenon is rightly justified. It seems the consensus regarding this potential fall-out is that it is more likely to follow the cadence of a slow bleed (periodic write-offs based on market) vs. a panic driven, widespread systemic shock like the Great Financial Crisis.
If you’d prefer to avoid office exposure more completely than perhaps Cullman Bancorp Inc. (CULL - Free Report) is a better fit. As of 12/22’s 10K we calculate the office loan exposure to be about 5% of the loan portfolio. The county of Cullman in Alabama is located about 50 miles north of Birmingham and led all 67 counties in industrial expansion and overall industrial projects in 2019. The population grew 1.14% last year and 15.29% since the last census of 2010. From 2010-2020 the county was the 9th fastest grower of the 67 counties.
The stock trades at about a 23% discount to Book Value of $14.48 and 16.5% to Tangible Book Value of $12.59/share. Trading liquidity in the stock is a risk factor so no market orders please.
Image Source: Zacks Investment Research
The graph below of the S&P regional bank ETF shows that while regional bank stocks have bounced back lately, they remain markedly lower than early 2022 levels. I won’t opine on the timing and duration of possible interest rate cuts. But my gut tells me inflation may prove stickier than expected due to three compelling structural forces in the economy which are inherently inflationary: labor shortage with wage inflation (barring major immigration reform), onshoring, and elevated fiscal spending. It seems that now we could have to live with comparatively higher rates than what we’ve been used to for many years. AI may enhance labor productivity and help blunt some of these forces but this may take a while to play out.
Image Source: Zacks Investment Research
My other opinion is that the mortgage market, which is an integral business for these banks, is relatively stable. This market has withstood interest rate hikes due to a chronic housing supply issue which will most likely continue barring any major NIMBY (Not In My Back Yard) reforms. And post financial crisis bank reforms appear to have reined in risky mortgage lending.
While these two stocks are arguably not multi-baggers anytime soon, they could offer a measured way to gain financials exposure within a portfolio. Both banks are profitable and trading at discounts to Book Value. Finding lesser-known pockets of population and economic growth within certain regions coupled with a compelling valuation can lead to regional bank outperformance. And discovery of this type of asymmetric information is often how microcap stocks outperform.
For more details about investing in microcap stocks, check out our Microcap Investing Primer