RealMoney Silver - Work on Your Insiders' Bank Shot

Work on Your Insiders' Bank Shot
By Jonathan Moreland
RealMoney.com Contributor
9/13/2007 1:00 PM EDT

As I noted in yesterday's column, although insiders have been buying up the financial sector in this correction, the only financial subgroup in which they have actually made consistent profits recently is small and regional banks.

This group is often bought by insiders, and it is usually ranked more bullishly than it should be by automatic insider scoring mechanisms that fail to differentiate properly between real open-market purchases and directors receiving shares in the bank as remuneration. But when I say that this group is working particularly well for insiders lately, I mean that I have dug into banks with insider histories and confirmed the buying as significant.

Frankly, I've never been too keen on adding banks to my newsletter's recommended list. Sure, you can try to game the constant trend of consolidation in the group, but I've never felt that analyzing the quality of a bank's assets was my specialty. I have also suspected that others were likely mistaken to think they were that much better than me at doing so. It's just too difficult to really get into a bank's asset portfolio. It always seemed to me that at some point, you're always left taking the bank's word on important facts.

All that is at the forefront now, however, and the truth will out in coming quarters about asset values as write-offs are forced by increasingly attentive regulators and shareholders. Not waiting for the inevitable confessions to come, investors have understandably sold stocks of small and regional banks as the credit-related storm builds.

But I'm finally ready to join insiders and have started to nibble at this group. I'm supplying a short list below of banks that have had significant insider buying since July, in case you want to take this leap of faith with me.

To be clear, I am not finally buying this group because I believe the credit crisis is over for them, or that it will pass them by. To the contrary, I expect that most banks -- including the ones with insider buying -- will have EPS estimates revised downward starting with the third quarter, and potentially going through 2008.

What I am betting on is that valuation metrics in the group are finally low enough (and the indicated yields are high enough) to buffer me against the confessions that are inevitably to come. That's a pretty brash thesis. But I'm only taking a small bet on it right now.

The metrics to pay attention to if you're deciding which bank to buy now, however, are not EPS estimates and indicated yields. These are how you pick bank stocks in good times. These are not good times, and metrics such as percentage of nonperforming assets, price-to-tangible-book-value and Tier 1 capital percentages are arguably more important to look at now.

Generally speaking, make sure Tier 1 capital is above 8%. And if nonperforming assets are above 1% of the total, the bank's stock should trade around or below a price-to-tangible-book-value of 2 to add comfort that you aren't overpaying.

Fed Up?

Frankly, I'm not sure if any bank bets now will end up being short-term trades or long-term holdings. I obviously hope the latter, but the Fed could soon determine how long these picks are held. The poor jobs data last Friday seemingly made the much-expected rate cut on Sept. 18 necessary -- much to the chagrin of investors, who apparently thought the Fed was just going to throw them the rate-cut bone without any data to back it up.

Though a rate cut of size should help bank stocks rise because of the improvement in near-term net interest margins it would cause, rate-cutting is a double-edged sword for banks. Any improvement to net margins would be negligible compared with the harm to assets that a real recession would cause. So, to the extent that rate cuts really are necessary, the net effect will likely be bad for bank stocks later this year if and when the recession becomes more obvious and if confessions from banks about nonperforming assets are larger than expected.

With this in mind, any spurt that bank stocks might get leading into the Fed meeting (or after, if any cut is deemed acceptable by the sentiment traders) might represent a good time to "sell on the news." Investors could lock in a profit on bets taken now and see whether banks stocks don't weaken later this year on third-quarter results and growing recession sentiment.

If you don't think the Fed is going to cut enough to satisfy the market, however, the play is probably to hold off buying now, and to buy after the stocks react badly to the Fed inaction.

Either way, the short list of insider-bought stocks below is as good a place as any to start looking for small and regional bank plays.

Banks With Insider Buying

Click here for larger image.