Small bank stocks are hot!

In the last six weeks or so I have noticed small bank stocks are pretty hot. I dove into some SEC filings and press releases.

I find many small banks are fundamentally sound and well undervalued. From a PE perspective there are many under 10. The balance sheets are as clean as I have seen them in the 18 years I have been studying balance sheets. I find now I can understand each line, versus five years ago the banks had so much extra gunk they themselves didn't always know what to make of their situations.

My theory here is after the financial collapse a few years back banks of all sizes were forced to clean up or go under. The banks which survived independently are therefore extremely healthy. Additionally, the banks which already had sound balance sheets were able to absorb some fairly interest rate spreads from the troubled banks or just coast along on their own strength.

Another phenomenon we have is the increasingly lower borrowing costs, resulting from stronger balance sheets. From about 2009-2011 what money small banks were able and willing to borrow was lent at a high interest rate. Now their borrowing costs are declining, enabling them to refinance existing debts, while extracting a larger spread on new loans.

Because of this, there is plenty of room for banks to expand their income base on the back of cheap interest rates, without falling into the trap if relying on fees generated to produce income. My contention is banks are at their best when they are generating healthy interest rate spreads, not on fees.

Over the next few days, if I choose to blog more, I will highlight a few of these small banks to help others see what I have been observing.

Thanks for reading.