Buy These 2 Small Banks for Big Bucks

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Marty Whitman of Third Avenue Value once said that if he could find a quality financial institution trading around 80% of tangible book value, the results were likely to be very positive. That statement has never been truer than it is today.

With small banks coming out of the banking and credit crisis, many of their share prices have been pushed to low levels. Now faced with a wave of new regulatory and compliance issues, many of them will be looking to combine with another bank or simply sell out to a larger competitor. Investors can easily profit from big-bank buyouts of their smaller banks, and a wave of mergers and acquisitions will usually move the valuation range of most of the industry higher.

Malvern Federal (MLVF) is a great example of a small financial institution at a cheap price with a sound financial condition. The bank has 8 branches in the Chester and Delaware counties of Pennsylvania. The bank has been around since 1897 and currently has about $600 million in assets. MLVF has a great balance sheet, with an equity-to-assets ratio of 10.9 and nonperforming assets that are just 1.98% of total assets.

MLVF sold the bulk of its problem assets earlier this year to an outside investor so that management could focus on running the business. The stock has sold off since October, when management announced that they had reached an agreement with activist investor Joseph Stilwell, heading off a proxy fight. However, Stilwell's organization got a board seat, and there are other activists involved in the shares, so the pressure to maximize value isn't going away. At 76% of book value, MLVF stock is screaming for investors to buy.

Home Trust Bancshares (HTBI) is another example of a cheap, well-financed community bank that has the potential for strong performance over the next couple of years. While the bank's nonperforming assets are a little above average at 3.87% of total assets, HTBI has plenty of excess capital. The equity-to-assets ratio is more than 20 as of the end of the third quarter, and HTBI has been using its capital to buy back HTBI shares below book value.

The bank has 20 branches in the Asheville, N.C. region and one in Greenville, S.C. Most of the bank's loans are in the single-family housing and commercial real estate markets, so loan qualities should improve along with the economy. At 84% of book value, HTBI has strong prospects for solid returns over the next few years.

I get somewhat amused every day by the thousands of traders who spend all day trying to figure out what the hot stocks like Twitter (TWTR) and Facebook (FB) are going to do every day. Owning stocks like these two banks — or ones I have mentioned before, like ESSA Bancorp (ESSA) and Charter Financial (CHFN) — will be a far more profitable and relaxing endeavor over the next few years.

As of this writing, Tim Melvin was long MLVF, HTBI, ESSA and CHFN.