This article originally appeared Sept. 5, 2013, on Real Money. To read more content like this, + see inside Jim Cramer's multi-million dollar portfolio for FREE Click Here NOW.One of longest-running and most profitable activities in the history of Wall Street is thrift conversion. Mutual thrifts were formed early in the last century to serve local communities. They are owned by the depositors, provide decent interest rates and protect capital. Most thrifts are extremely conservative and make very smart loans with low loss rates. Then in the 1970s, banking regulations changed and mutual thrifts that desired to be public companies converted to stock ownership, creating a profit opportunity. Let's look at the public offering process for a fictional thrift institution with $50 million of equity. It prices the deal at the equity value and sells five million shares at $10 apiece. Depositors get the first shot and any unsold shares are offered to the public. Upon completion and receipt of the cash, we now have a bank with five million shares outstanding, the original $50 million of equity and a fresh injection of $50 million from investors. The equity value of the new institution is now $100 million and the book value of those $10 shares is now $20. This is a simplified example, but most thrift conversions are done on similar terms. This attracts not only profit-seeking investors but also other banks looking to expand their asset base on attractive terms. A converted thrift couldn't be bought out right away as there is often a waiting period for officers and directors to sell shares, pay dividends or buy back shares, but after a year or so, larger banks could still purchase the excess capital and clean loan book on favorable terms. In fact, in a study shared by FJ Capital, 76% of all thrift conversions have been bought out less than five years after completing an IPO. This has been the case most of the time up until the recent credit and banking crisis that began in 2007. Takeover activity of all types in the financial sector slowed to a virtual stop as asset values collapsed. Banks were losing money as collateral values tanked and borrowers were unable to pay back loans. This applied to thrift conversion as well, and when I look at conversions of the past few years, the takeover rate is not even close to 75%. As the banking industry continues to recover, that's going to change, and these capital-rich institutions with solid balance sheets are again going to become attractive targets for larger banks. If we look at conversions done in 2008, we should find that 75% of these banks have been taken over by now. Ten conversion deals were done in that difficult year yet only one bank has been taken over, and one other has a deal pending that should close later this year or early next. That leaves eight banks that are overdue to be taken over. They will likely be targets once bank merger & acquisition activity begins to accelerate. Of the remaining eight banks, four are large enough to discuss on Real Money that still trade below book value. They have weathered the storm of the financial and banking turmoil of the past five years and are still in good shape, with plenty of capital and manageable non-performing asset levels. Malvern Bancorp (MLVF - Get Report) serves Chester and Delaware counties in Pennsylvania. The shares currently trade at 80% of tangible book value and have an equity-to-assets ratio of 12.3 Nonperforming assets are currently 3% of total assets, which is the highest ratio in this group. Cape Bancorp (CBNJ - Get Report) operates in the Atlantic and Cap May counties of New Jersey. The shares trade at 90% of tangible book value with an equity-to-assets ratio of 12.85. Non-performing assets are just 2.2% of the total asset base. The bank recently authorized another 5% stock buyback. Home Bancorp (HBCP - Get Report) serves the greater Lafayette, Baton Rouge and North Shore regions of Louisiana. The stock fetches 90% of tangible book value, and the equity-to-assets ratio is 14.1. Nonperforming assets are 2% of total assets. The bank recently completed a 5% buyback and it has announced another one. Sound Financial (SFBC - Get Report) is in the Puget Sound area of Washington. The shares trade at 90% of tangible book value with an equity-to-assets ratio of 10. Nonperforming assets are a miniscule 0.64% of total assets. This bank is also on the buyback bandwagon, with a recently announced 5% repurchase plan. These four small banks are safe, cheap and overdue for a takeover. Patient investors could make a lot of money with these names in the next few years. At the time of publication, the author was long MLVF, CBNJ, HBCP, SFBC.
A Thrifty Proposition
Sep 07, 2013 | 01:20 PM EDT
Check Out Our Best Services for Investors
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Model portfolio
- Stocks trading below $10
- Intraday trade alerts
More than 30 investing pros with skin in the game give you actionable insight and investment ideas.