2 Small Bank Stocks With Huge Upside

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I have written often about the potential for small bank stocks during the next decade. The regulatory and economic hurdles facing the smaller banks is going to force many of these institutions to merge with a larger competitor, and that's going to be a source of huge profits for patient investors.

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Deals will be completed at a price higher than the current market price most of the time — in my personal opinion, it will come at a multiple of book value ranging from 1.25 to as high as 2.5. Focusing on those little banks that trade below book value will allow investors to find stocks that have huge upside potential when a deal finally happens.

One way to find these little bank stocks with the potential for big returns is to focus on former mutual thrifts that have undergone the conversion process and are now stockholder-owned institutions. Since the conversion process was developed back in the 1970s to allow thrifts to go public, the vast majority of these high-quality small bank stocks have been taken over within the first five years after the deal closed.

The credit crisis slowed the pace of deals temporarily, but there are plenty of former thrifts trading at low valuations that have the potential for large long-term returns.

Home Bancorp (HBCP)

Home Bancorp (HBCP) is a 22-branch bank located in Lafayette, La. The bank has almost $1 billion in assets and the balance sheet is in excellent condition. Also, its equity-to-asset ratio is 14.5 — well above my preferred minimum of 10. Meanwhile, Home Bancorp’s nonperforming assets are just 2.09% of the total.

HBCP recently announced a deal to buy Britton & Koontz Capital Corporation (BKBK) in a deal that will add eight branches and more than $300 million of assets to the bank. It also gains access to the Mississippi marketplace and increases Home Bancorp’s deposit base in Baton Rouge.

HBCP stock is trading at 94% of book value and is very attractive at the current price.

Simplicity Bancorp (SMPL)

Simplicity Bancorp (SMPL) in Covina, Calif., started out decades ago as a credit union for employees of the Kaiser Foundation Hospital. It has since grown to a nine-branch bank with $834 million in assets. SMPL had its conversion IPO back in 2010, and is an extremely attractive takeover target right now. The bank’s equity-to-asset ratio is 16, and nonperforming assets are less than 2% of the total, so that’s a solid financial condition to be in.

Management has been using the excess capital to buy back stock and just announced another 5% share buyback for next year. SMPL stock is trading at just 85% of book value and is an outstanding bargain right now.

Simplicity’s branch network is one of the most attractive regions of California, and I would not be surprised to see a larger bank make an offer for Simplicity next year at sizable premium to the current level of SMPL stock.

Bottom Line

I refer to small banks as the most boring way to get rich in the stock market. While everyone else is trying to figure out where Apple (AAPL) is going to trade today, or if JCPenney (JCP) is going to recover, the patient ownership of small bank stocks will be a far more profitable approach — without all the volatility and angst of other strategies.

As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.