Equity Research: Community Financial Institutions and Other Financial Services Companies/Andrea Psoras – November 2010

Equity Research: Community Financial Institutions
and Other Financial Services Companies
/Andrea Psoras – November 2010

SectorCommunity Financial Institutions and
Other Financial Services Companies*

Sector Profile –
Although the financial sector for the last 3 years overall has been encountering a necessary market correction with the big Financial names most severely affected, many community financial institutions and other small-cap financial services companies have survived as very investible, solid portfolio holdings and additions.

With regard to share price recoverability, some savvy investors in these names may have eaten some of the market downdraft or in 2007 saw the correction coming and if not – sold or shorted, or put on options, some of the banks and thrifts that were in areas of the US not very affect by the ‘free’ trade agreements and what results from those often which is the off-shoring of production out of those localities and an associated contraction of those local economies – prudent managements which survived that and the market correction through later in 2009 into the present time saw their stock prices returned strongly. Some may say it’s because buy side will hunt down into the market caps above $1B however, these names remain investible despite that actuality that is produced by the investment flow volumes from the buy-side.

Investors who know this sub-sector also know they’re buying more real earnings and with franchises that are producing and thus enjoying positive operating cash flows from performing lending and safe and sound banking practices. What sour assets a management may be encountering, it has sufficient operating cash flows to address write downs of asset values. And as long as these smaller names have remained well capitalized and with solid earnings, they continue to pay dividends.

Moreover, the better performers in the sector exist on the targets of larger financial players which are looking for quality franchises and market expansion. This means investors are bought-out at higher prices, although they’ll loose a good name in their portfolios.

Further, and although perhaps an underappreciated quality, these names also survive Socially Responsible Investing ie, “SRI” screens. As a result these names would appeal to pension fund managers of union and state pensions. Except perhaps for Community Reinvestment Act (“CRA”) non-compliers, there infrequently is anything about the operating strategies of the names in this group that generally trigger most of those rejection metrics, thus often surviving to enjoy Socially Responsible Investing status. With an estimated $2T under managed under SRI and similar selection screens, this buy-side muscle helps stand in for price support and better price appreciation.

Additionally in that these enterprises are domestically based, they focus their business regionally and locally while employing Americans. These names remain the pure commercial/community banking model in the US providing necessary commercial banking products and services in their localities. The big Financials however, have focused on non banking activities meanwhile engaging in aggressive OTC and derivatives contract writing and trading in part used to inflate their Balance Sheets for the fair value goose or “game” to their Income Statements. If not hedging for itself, Management says it is providing these contracts on behalf of client interests. Off or on-balance sheet, notwithstanding, many of the big Financials via that aggressive writing/trading OTC and Derivatives contracts have vastly obligating the resources of their enterprises and remain insufficiently capitalized and/or without adequate positive operating (real) cash-flow to engage in these so called risk hedging or ‘insurance-like’ contract activities.

As it were, community financial institutions and some of these other financial services companies engage in very little to virtually none this non-cash and in effect, unsafe and unsound banking activity, and again produce real earnings and also dividends to the investor.

I also have included names of other non-depository financial companies which provide financial goods and services to both the ‘retail’ and commercial counterparty. In some cases these names have unique qualities or activities warrant coverage and support given their qualities. On a 5 year back-test against 41 other indexes and funds such as Exchange Traded Funds, this universe outperformed all but 4 of those which were used as stock price performance measures.

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