Investing in community banks: Is now the time?

Considering the volatility of both the stock market and the banking industry, some investors might believe that it’s best to steer clear of bank stocks completely. However, some analysts believe that investing in community banks or regional banks can pay off.

Thomas Alonzo, who is an analyst at Macquarie Capital, says many community banks aren’t dealing with the debt issues that larger financial institutions face and can have a healthier capital-to-debt ratio, which could put them in a much better position once the stock market begins to improve. Also of note: Timur Braziler, who is an analyst at Keefe, Bruyette & Woods, says that despite some industry turmoil, regional banks in the Northeast, such as Berkshire Hills Bancorp, First Niagara Financial and NBT Bank, have expanded their businesses.

Berkshire, which has branches in Massachusetts, New York and Vermont, announced in October that it signed a merger deal with Connecticut Bank and Trust (CBT) by which it would increase its presence in Connecticut. Braziler believes that the $30 million that Berkshire will pay is a fair price, which has quelled investor concerns. (Keefe, Bruyette & Woods holds shares in Berkshire.)

First Niagara, which services the Northeast region, is expanding its business in upstate New York through an acquisition of branches that are being sold off by HSBC. That, too, is good, but at the same time, First Niagara has initiated a process to raise $800 million in new capital. The problem: This could result in stock dilution, Alonzo says. Unfortunately, the specifics of the acquisition and the potential dilution probably won’t be worked out until some time during the first quarter of 2012. (Macquarie holds shares in First Niagara.)

NBT, which has branches in Massachusetts, New York, Pennsylvania and Vermont, is expanding into New Hampshire through a $45 million merger with Hampshire First Bank. The merger is expected to close during the second quarter of 2012. Braziler says NBT has strong assets and has withstood the low-interest-rate environment. He believes that entering a new market will give NBT an opportunity to build its customer base and the liquidity (available cash) that’s generated by customer deposits could lead to potential loan growth. (Keefe, Bruyette & Woods also holds shares in NBT.)

Of course, not everyone is convinced that the time is right to move on banking stocks. Brice Rowe, who is an analyst for Robert W. Baird & Co., believes that investors should hold off on the entire banking industry for the foreseeable future. Low interest rates, deposit growth that outstrips loan growth, and deposits that are being invested in relatively low-yielding assets are all of the negative factors, he says. He also says that if the stock market takes another downturn, it will affect the shares of banks—of any size. Rowe believes that bank stocks will be a good bet after both the economy and the job market improve.

For investors who want to keep community or regional banks in consideration, Alonzo says you should make sure that a bank’s level of capital is strong, that its nonperforming assets are minimal, and that it has potential for geographic expansion (a sign that the company can grow). Alonzo believes that if investors can ride out the next couple of quarters, they could profit over the next couple of years. “If you can look out 3–5 years, it’s probably not a bad time to dip a toe in the water,” he says.

– K. Fanuko