12/14/98 A BIG SCORE IN LITTLE BANKS?

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A BIG SCORE IN LITTLE BANKS?

If you missed the chance to buy on the market's recent dip, don't despair. Some cheap stocks are left--maybe right in your backyard. Based on estimated 1999 earnings, shares of the nation's 1,340 publicly traded community banks are selling at a 36% discount to the Standard & Poor's 500-stock index. That's ''at the lower end of their historical range'' of half to equal the S&P's value, notes Mark Fitzgibbon, managing director at Sandler O'Neill & Partners, a New York investment bank.
Small-bank and thrift shares--which are selling at an even deeper discount--have been punished by pessimism over near-term pros-pects for takeovers in their less-liquid corner of the market. But many small banks are flush with equity, giving them higher capital levels than their larger brethren. Money center and regional banks have capital equal to 7% of assets, while community banks (with assets between $100 million and $10 billion) have about 9%, says SNL Securities, a financial-research firm in Charlottesville, Va. Thrifts, on average, have capital ratios of 13%, with some nearing 30%--26 percentage points more than required by regulators.
Excess capital can finance mergers or business ventures to enhance returns. Capital can also be distributed to shareholders through dividends or stock buybacks. But there's a reason small banks husband resources. When the economy sours and loan losses mount, they have a hard time raising money. So even in flush times, they keep extra capital on hand for protection. As a result, even as the strong economy has helped banks large and small create five consecutive years of record earnings, the lenders' return on equity has remained puny (table). ''Wall Street doesn't like them because they're underleveraged,'' says San Diego value investor Charles Brandes, who has been accumulating shares of undeRperforming lenders in hopes of revived profits or takeovers.
Not every bank is a merger target. Some community lenders' shares are concentrated in the hands of insiders resistant to change, says Bert Ely, an Alexandria, Va., banking consultant. Takeovers of banks in slow-growing markets are also unlikely. That's the reason Ely counsels avoiding ''anything with an ROE below 12%, unless you have good reason to think something is going to change in the near future.''
Still, plenty of underachievers merit a look. Keefe, Bruyette & Woods, an investment bank that specializes in the banking Industry, likes Mercantile Bankshares of Baltimore and Houston-based Prime Bancshares of Texas. Both are in fast-growing markets and have enough capital to repurchase stock, making them alluring to suitors and investors. Mercantile is fairly priced compared with its peers, but Prime Bank is cheap at 12.2 times estimated 1999 earnings of $1.45, says Keefe Bruyette analyst Marni Pont O'Doherty.
Meanwhile, Jerome Davis, a Greenwich (Conn.) Shareholder activist, owns stakes in about 25 savings and loans. He is trying to persuade two tiny ones that went public recently, GS Financial of Metairie, La., and United Tennessee Bankshares of Newport, Tenn., to pay hefty one-time dividends to reduce their capital levels of about 32% and 26%, respectively. GS Financial President Donald Scott says a special dividend is ''an option'' if a five-year plan to expand mortgage lending and add services doesn't boost returns. United Tennessee President Richard Harwood didn't return calls. Although both have purchased stock already, ''there is a serious risk of underperformance,'' Davis says of GS Financial,whose ROE of about 4% trails even United Tennessee's lackluster 6%.
Buying stock in a small bank or thrift requires much analysis and a leap of faith. A lot of value is buried in some banks' fat balance sheets. But unless management is willing to engineer a turnaround or sell to someone more capable, what looks like a bargain could be a bust.
By Anne Tergesen

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