A case for investing in small cap banks

by PlanMaestro

Continuing with our most important theme lately, today in Bloomberg there is an interview with mutual fund manager David Ellison. It points out pretty well the case for investing in small banks while noticing other investors worries.

As usual, I do not like the specific recommendations.  It looks like most mutual fund managers share for public consumption only their most sanitized ideas. So as consequence the recommendations have little edge and are only slightly undervalued. Pretty understandable: little to gain, much to loose

On turnarounds

David Ellison learned a simple lesson from legendary mutual-fund manager Peter Lynch as a young bank analyst at Fidelity Investments in the 1980s: If things at a company are getting better, you want to own its stock.

On banks today

We’re in the process of going from ugly to OK in banking. If you ride the right horses, you will do all right

This is the best time to be making loans I have seen in my career

Bad loans across the industry will be paid or written off over time and replaced by newer and better ones. Banks are lending to creditworthy customers and earning higher profit margins after former competitors such as mortgage companies were wiped out in the financial crisis and housing- market decline

On survivors

The institutions that have survived to this point will rise from the ashes

Smaller banks have fewer moving parts. These guys are the basic American lenders. They will grind through it

A continuing shakeout will eliminate weak players and allow the surviving institutions to gain size and strength. Consolidation will provide greater benefits to small banks because some may be able to double or triple in size

On the new regulatory bill

Would have a limited impact on small banks because they don’t invest in hedge funds or engage in proprietary trading, activities the legislation is designed to restrict. The overhaul will create uncertainty for larger banks without crippling their profits

On management in turnarounds

Ellison recalled that he once hesitated to tell Lynch to keep a bank stock in the portfolio because he didn’t like the company’s management. Lynch listened to Ellison and replied, “But do you think the company is getting better?” When Ellison said yes, Lynch decided they should hang on to the stock. “I learned a lesson,” Ellison said. “People matter. Profits matter more.”

On the economy

An economy that expands 2 percent to 3 percent a year will be enough to support an improving credit climate