New SmallCap Bank Service

Welcome to Community Bank Investor - by Tim Melvin

Not the best time to be rolling out a service for stock investors of any stripe or form.

However, for those that jump in and take advantage of this year and put money to work, you are going to be locking in some ridiculously low prices in one of the very best segments of the stock market.

I am talking about the community bank segment.

Now, I know that sounds really boring.

It is not super high tech.

It is not AI.

It is not a whole bunch of different things.

This is exactly why it works.

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My Banking Journey

Banking is probably my favorite investing sector. I've been investing in banks for over thirty years now.

I first became attracted to banks when I moved back to the Annapolis, Maryland area in the early nineteen nineties. I had moved out west to the central San Joaquin Valley of California.

For about three hundred and twelve million different reasons, I decided that California, especially that part of California, beautiful state though it is with a lot to love about it, wasn't a great fit for me.

I moved back home to Annapolis and joined a small regional bank firm. I was in there every night just working away, cold calling and building a new clientele. We had an older gentleman in our office who I became great friends with over the years.

He got in at about 9:28 just before the market opened.

He took a good hour and a half, two hour lunch every day.

I never knew the man to be late for happy hour.

He made a ton of money, had the beach house, had the big house in town, and had a really nice lifestyle in spite of really not working a whole lot. So I started asking around. I asked, "What is the secret to this? How does he do this?"

Turns out he invested in community banks. He understood banking. He knew all the bankers from his long experience living in the community. He knew all the bank stock investors. He knew the business people. He knew the real estate people.

He just understood that these small businesses, locally owned and locally run banks were licenses to print money.

This was before the savings and loan crisis, obviously well before the great financial crisis. These small locally owned banks started by local business owners—I mean, your fifteen percent return on equity was doable anytime.

If you can get a fifteen percent return on your money as a local business person with a relatively low risk business, it was just, to me, an easy decision.Many of themlots of them had started banks, they all invested in banks, and he was making a ton of money just facilitating transactions in these small bank stocks.

I immediately became very interested because the phrases "lots of" and "money" have always appealed to me.

The Ultimate Win-Win

This was probably the ultimate win-win-win in Wall Street.

This was before they changed all the rules. There were huge spreads on these stocks. As brokers, we made a ton of money, but we were airing these fat spreads on bank stocks trading at very low multiples of tangible book value.

Then, once Bill Clinton came along and signed the interstate banking legislation in 1994, a takeover wave smashed into the small bank segment of the market.

Subsequently we were selling them all back out for one and one and a quarter and even one and a half times book value just a few years later.

You had the aftermath of the S&L crisis that sent the prices of good banks with solid balance sheets down to very low multiples of book value that eventually got taken over.

The brokers made a lot of money.

The firm made a lot of money and the customers made enormous amounts of money.

I started to really dig into and understand and learn the banking industry.

In regular times, you had a bunch of banks that you could buy that met certain characteristics. Eventually, they grew or they got taken over.

Either outcome was a win for investors. If you follow the simple rules, you never got caught in a bank that went under.

Even as we got through the great financial crisis and the long-term capital blow up, there really were not any operating problems because of these few simple rules. Following these rules meant you really could not get in deep trouble.

The Great Financial Crisis Test

The big test came along, of course, with the great financial crisis.

Bank M&A in the early 2000s coming out of the internet bubble bursting was booming, to say the least, and multiples got quite extended.

As I recall, we got up to takeover multiples over two times book as a very normal event.

As we were selling banks that we had purchased earlier at very low multiples of book value, selling them at high values, there was nowhere to put the cash.

There were no banks that checked all of the boxes.

By this point, I had really learned you do not break the rules.

If you never break the rules, you really do not get in trouble.

I did not break the rules, had tons of cash, just sitting there. Had it not been for SPAC arbitrage and a little bit of risk arb, I might well have starved to death in 2007.

The great financial crisis comes along.

Those banks that emerged in late 2009 that never had problems, did not get onto the problem bank list, stuck to their knitting, had high quality loans, lots of capital on the books, and had resisted the urge for stupidity—these banks were screaming buys at fifty or sixty percent of tangible book value.

Once more, the M&A wave came right back into play and has continued pretty much right up through today.

Patient agressive investors who knew the rules made a lot of money

A Proven Strategy

Here's what you have: You've got a strategy that It has earned three to four times the overall return of the stock market. There have been very few net down years going all the way back to 1999.

More importantly, you've had very low turnover.

You have had a beta of 0.35. That means every time the market moved up and down by a dollar, these stocks only moved up by thirty-five cents or so. Most of your exits were because of a takeover.

We had a service that we ran for years and years on a site that's no longer around. And we closed over 120 transactions over about a ten-year period. There was one loss the whole time. That was a three percent loss on a very small bank in Illinois that got taken over by a credit union on a discount because the executives were just sick and tired of being bankers. Basically, they wanted to move on.

We have closed all of these trades with no losses, lots of big gainers, exiting primarily via takeover.

We hold these banks until something really good happens, until either business gets so good and they are growing so fast that they get above like 1.75 times book value.

9We have had a few of those.

Mostly it has been via takeover.

We have learned what that secret sauce is over the years.

There are specific measures of capital levels, of loan portfolio quality, valuation, and a couple of other not quite as quantitative factors that boost the odds up in our favor.

Private Equity for Individuals

I compare it to private equity investing for individuals.

We are not trading stocks. We are buying businesses that happen to be banks. We know that there is a massive consolidation wave in the banking industry and it is not going away.

We still have somewhere between 4,500 and 5,000 banks, plus another 400 or so mutual thrift organizations and 2,700 credit unions.

Last time I looked, we have too many financial institutions. We are also now in an environment where literally bigger is better.

If you look at the banking industry and rank by market capitalization and return on equity and return on assets,it is a linear relationship.

The more assets you have to deal with fixed costs like regulatory issues, technology, cybersecurity, employee compensation, attraction and retention, the more assets you the better your bank is going to do, The larger the asset base, the higher returns on assets and on equity your bank is going to be able to earn.

The Growth Challenge

Banks are in search of scale and growth, but we live in a plus or minus two percent growth world. Looking at the Fed's projections going forward, it is going to be minus for the next several years in all likelihood, particularly if the trade war we are seeing unfolding continues to build steam. That is going to slow the global growth rate a little bit.

It is really hard to just grow by opening another branch in the next town.

First off, there's already a bank branch on two of the four corners with a McDonald's and a Wendy's on the other two (or Starbucks, obviously). I

t is kind of hard to grow your bank at a rate that is going to be attractive to investors, that will make them want to buy and hold your bank stock.

The Smart Banker Approach

Now, if you buy a bank and you're good at i, thereis a lo tof money to be made for your shareholders.

I like to use John Allison as an example. I wrote an article that was slightly critical of John's bank one time, Home Bancshares (HOMB) in Conway, Arkansas, because it was trading at three times book at the time.

John called me at home on a Saturday morning.He called me up and said, "Look, I think you were unfair to my bank." I said, "Okay, let us do an interview and let us talk about it."

We did.

About halfway through the interview, I realized that John Allison was one of the smartest guys I had ever met in my life. He was a businessman who just happened to be in banking. John would have succeeded in any business he was in.

He ran his banks very efficiently with a very high return on assets of about two percent. John's approach was simple: he went out and found underperforming banks that had plenty of capital. In other words, there was no distress here.

The loan portfolio was pristine and clean.

He was not buying into a bucket of problem loans.

They were just too small to operate efficiently.

Maybe they were earning fifty basis points of ROA compared to his two hundred basis points.

He would buy their bank, wipe out about thirty-five percent in fixed costs and achieve synergies across the board, then up the return on assets by a multiple of three, three and a half, four times, thereby adding a tremendous amount of money to his bottom line that the smaller bank, frankly, never could have earned.

Scale Matters

So scale matters.

There are plenty of banks that need to be buyers and there are banks that can't keep up. Regulatory costs are skyrocketing even under the Trump administration.

They continue to go up year after year after year.

We're going to get some rollbacks, but not enough to really make a dent in the costs. We'll just keep the costs from going higher, hopefully.

Technology and cybersecurity costs are astronomical.

AI may help some of that, but not for a while going down the road because you've got the regulators and they're going to have a vote on how AI is used.

Thanks to John Allison and other bankers at conferences, we kind of know what the acquiring banks are looking for.

The bankers are looking for almost exactly the same as the factors we all figured out back in the early 1990s as key determinants of bank returns.

So we're able to buy banks at bargain prices with small valuations that are financially strong

They need to sell.

There are buyers that need to buy.

We just have to come together on price.

The consolidation wave is not going to end any time soon.

Our Approach

It sets up a strategy that definitely beats the market. It's very low beta.

It's like private equity for individual investors. Again, we're buying banks. We're holding them for a very long period of time. We're not trading about trading around them as long as the factors don't change.

They remain high quality.

They have lots of capital.

They are not embracing stupidity in the loan portfolio.

As long as all of these factors remain true, lower prices, like we have been seeing a little bit this week with the big sell-off, just make us want to buy more.

That's what we're going to do with Community Bank Investor. We're going to use a deep value approach like Ben Graham, like Marty Whitman, like Warren Buffett used to buy banks in the early days of his career when he was racking up fifty percent a year returns.

We are going to take that approach

We are going to add in the mindset of a private equity investor where we are just going to buy it, hold it, collect some dividends maybe along the way, let the value get increased by stock buybacks.

If they grow their way out of it and we get this huge return because the bank itself was able to grow, fantastic. We are very happy about that.

If they sell and we bought something at seventy-five percent of book value or eighty percent of book value and they sell it at 1.3, 1.4, 1.5 times book value, that has also gone up by five percent a year during our holding period, well, we are not going to complain very much about that either

What to Expect

We cannot promise that every stock is going to go up.

We cannot promise that every stock is going to be a winner.

We can tell you that all the stocks that we have owned, and it is hundreds of them over the last twelve years now using the strategy that we could document (and thirty years in reality), we have had very, very few losers.

The idea is the consolidation wave is going to go on for an extended period of time. It should accelerate under the Trump administration.

You have got a lot of small bankers all over America right now that just looked around.

They are looking at what could become an economic mess.

They founded the bank back in the nineteen nineties when there was lots of bank creation and de novo activity.

They are in their late sixties, early seventies.

The only way out is via the sale to a larger institution.

A lot of larger institutions know that they need to get back on track. They need to make some deals to gain more scale, to be able to expand their offerings, to be able to increase their returns on assets and equity, to be more attractive to investors, to keep themselves from becoming a takeover target.

Join Us

So we have got this great industry with a fabulous consolidation wave.

We know the rules.

We stick to the rules.

As long as we do that, we are going to create a portfolio that we think can deliver market-beating returns.

Most of the time, you are not going to experience the same amount of volatility as you might with a lot of other strategies.

We are rolling it out on a very interesting day. I think I priced it pretty fairly. It is going to be $499.

I have offered this similar service at $499 since I left the brokerage business. I am told repeatedly by publishers and by friends and associates and bankers that I should be charging a lot more. They are right.

This is a lot of work. I

spend a lot of money on resources. I could and should, and with the track record especially, we could and should charge a lot more.

I do not want to. There are a lot of folks out there that cannot afford to be paying four and five thousand dollars for their investment services and their subscriptions. But they have got money at work.

No one has ever told them about the magic of community bank stock investing. They are not exposed to it.

They cannot use it. It is not like it is a field where you could just dive right in and know all about it overnight.

I want to make this available to everybody individuals looking ot grow their stack with maybe ten to fifteen years to retirement. They want to get there. Thye want to get there in style.

But they cannot sit through another crash.

Thye cannot have another forty, fifty percent of his net worth permanently wiped out.

He cannot have his money eaten away by the ravages of inflation.

Yes, I want the bankers. I want the investment bankers. I want all those folks to still subscribe, but I also want the people that just want an approach that can help reduce volatility while maintaining a high return.

What's Next

That is where we are. I hope that you join us. Things are in a free fall and the banking industry has been kind of up at the upper levels of valuation. We do not have a ton of banks to get started, but the list is growing and should continue to grow if this madness continues.

We will have the first five or six banks in the portfolio up on the site this week.

I will have full write-ups to you guys on the banks, so you know exactly what you are buying over the course of the weekend.

Thank you. I hope you join us. I hope you stay with us. I am glad you joined us. I hope you stay with us for a very long time because that will mean that we have all made just a ton of money together. That is sort of the purpose of all this.

Thank you, everybody.

Have a great weekend.

Keep your head down.

This too shall pass.

If you are investing in small banks, you did not need to worry about it in the first place.