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INVESTING: Now may be good time to buy small banks

December 17, 2007

Are Indiana bank stocks on sale? Performing a cursory analysis on the list to the right of this column, an investor could answer that question with a qualified yes.

It is noticeable that the Indiana stock list is populated with a good number of small com-

banks.

of these bank stocks pay attractive dividends, sell below their book values, and are trading at prices near multiyear lows.

For example, there is River Valley Bancorp of Madison. River Valley's stock is hovering near a five-year low and is selling for about 95 percent of book value. And in a sign of confidence, the bank's board just raised its dividend for a yield of 5.8 percent. The P/E ratio is around 12 and the bank has $350 million in assets. River Valley's earnings will increase if it can grow deposits and boost return on assets above a current 0.6 percent.

Then there is MFB Corp. in Mishawaka, which has increased its dividend yield to 2.9 percent and is selling for 85 percent of book value. Northeast Indiana Bancorp in Huntington raised its dividend to yield 4.9 percent and is priced at 80 percent of book value. Logansport Financial sells for 70 percent of book value and pays a 4.25-percent dividend. And the list goes on.

There are several things to keep in mind when investing in small Indiana bank stocks. Many are illiquid; that is, the trading volume in these stocks is sporadic. It is not uncommon for these stocks to go for days without any trading and, at best, a few thousand shares may trade on a given day.

Also, these stocks might still sink lower in price. We may or may not be heading into a recession, but economic growth certainly is slowing. These banks serve regional communities, taking in deposits and making loans. When investors get pessimistic about the economy, bank stocks can drop well below their intrinsic value. More in-depth research will yield answers as to the composition and quality of their loans, and the potential for increasing loan losses. However, in general, most of these banks should not have the exposure to the subprime problems now being experienced by the bigger banks.

Of course, near-term weakness should be of no concern to a long-term investor who is eager to pick away at bargains and has the patience to wait for the payoff. Such an investor is willing to buy even more of these stocks if they drop further-an attitude you should have with just about any investment you make.

Interest rates are dropping. That is good news for banks, which earn the spread between short-term depository rates and longer-term loan rates. Plus, investors enjoy a healthy dividend while they wait. The eventual payoff may come from acquisition activity, as larger banks seek to enter a particular community. Or, a few years down the road, earnings pick up a bit and the market realizes the value that resides in these small bank shares.

Finally, a disclaimer: Our firm holds some of the stocks mentioned here, and may in the future buy or sell the bank stocks mentioned in this article for our clients.



Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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