If I Had Cash, I Could Make a Lot of Money Right Now
By Dr. Steve Sjuggerud
October 2, 2007
"Oh boy, if I had cash, I could make a lot of money right now," a bank executive (who doesn't wish to be named) told me over the weekend.
My friend and I were talking about buying shares of community banks – smaller, local banks. This banker was so excited about the idea, I think he levitated for a moment or two.
I think we're nearing a great opportunity for these banks. "Nobody is talking about them," I said. The shares are down big time from the subprime mess.
Meanwhile, we're entering the "sweet spot" for banks. You see, short-term interest rates are going down... but long-term interest rates are going up. Banks make money in one main way – by taking in money at a low rate and investing it at a higher one. It's an easy way to make money – with no risk – if interest rates keep doing this...
"That's not all Steve," my friend said. "The reality is, many of the small community banks don't have the problem assets the big guys have. I run a small bank in Florida. We never did any subprime loans. And all we bought was government-agency-guaranteed stuff."
He described the situation: "I know of a few community banks for sale in Florida, but nobody will touch 'em because they don't know what they're holding. At a certain point though, these might be attractive takeover targets. So there's a floor to the prices here, and we're probably getting close to it. I think you'll start to see more mergers and takeovers with these prices."
And he hit on yet another important point: "There's another thing you're probably not thinking of also… At least half of the mortgage industry has gone out of business in the last three months. It's taken the competition out for us. We're not competing with mortgage brokers anymore. Banks are the only ones that have the money to make loans. With less competition, that means more profits for banks like mine."
No competition from mortgage brokers, bigger profits thanks to a larger interest rate spread, and the potential for takeovers… Small banks are starting to sound attractive.
Even better, the value is there. Banks in general are the cheapest they've been in more than a decade on a price-to-earnings and a price-to-book value basis. And they're paying the highest dividend yields in 10 years as well. (All data are based on Datastream's U.S. banks index.) An important footnote here… while banks are as cheap as they've been in a dozen years, they were even cheaper back in the 1980s.
You can see why my banker friend says, "If I had cash, I could make a lot of money right now." The reality is, he's already invested. He's in the community bank business. He's an owner. In a way, he's as invested as it gets in this business. And yet, he'd invest even more at this moment. He's right. Nobody is talking about them.
To me, they 1) are cheap, 2) are ignored, and 3) seem to be in an uptrend, as it appears the bottom was hit on August 15 – just what I want to see in an investment.
The big risks for us are that we may be way too early since we don't know how deep the housing crisis will go. And we don't want to pick the wrong bank.
But I'm willing to stick my toe in the water. You might want to consider it, too…
Good investing,
Steve
Editor's note: Steve Sjuggerud is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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