5 Small-Cap Bank Stock Winners Nobody's Talking About

NEW YORK ( TheStreet) -- In a hot market for bank stocks, it may pay for long-term investors to consider smaller community banks in addition to the large-caps that receive so much daily coverage.

After a second-quarter hiccup, bank stocks have been strong, despite several near-term challenges for the industry.

Following a 25% decline during 2011, the KBW Bank Index ( I:BKX) has risen 30% year-to-date, and 12% since the end of June.

While it was easy to spot potential bargains at the end of last year, by isolating undervalued names to those trading quite low to tangible book value, things are not so simple now, and returning to a focus on names with strong business models and growth potential seems the order of the day.

Among the "big four" U.S. banks and the largest two investment banks, KBW rates three names outperform heading into third-quarter earnings:
  • JPMorgan Chase (JPM) has seen its stock return 30% year-to-date, through Friday's close at $41.82. The shares have recovered most of the value they lost following CEO James Dimon's announcement in late May that the company was facing large second-quarter losses from trading activities within its Chief Investment Office. JPMorgan announced soon after that it was suspending its share buyback program, but after the company achieved a $5 billion second-quarter profit, despite $4.4 billion in hedge trading losses, Dimon said that the company might be able to resume buybacks in the fourth quarter, subject to Federal Reserve approval. The shares trade for 1.3 times tangible book value, according to Thomson Reuters Bank Insight, and for eight times the consensus 2013 earnings estimate of $5.21 a share, among analysts polled by Thomson Reuters. The company will kick off third-quarter earnings season for the large banks on Friday, with a consensus EPS estimate of $1.22. KBW analyst David Konrad as a $49 price target for JPM.
  • Citigroup (C) closed at $34.77 Friday, returning 32% year-to-date, following last year's 44% decline. The shares are trade for 0.7 times tangible book value, and for eight times the consensus 2013 EPS estimate of $4.53. The company will announce its third-quarter results next Monday, with the consensus among analysts being a 96-cent profit. Konrad last Tuesday upgraded Citi to an "Outperform" rating, from "Market Perform," while raising his price target for the shares by four dollars to $44. The analyst said that even though the shares appeared "cheap," the "primary drivers" of the upgrade included "1) expectations for continued run-off of Citi Holdings following QE3; 2) improving Basel III capital ratio; 3) expectations for capital deployment in 2013; and 4) expectations for continued market share gains in global trade finance."
  • Shares of Goldman Sachs (GS) closed at $119.31 Friday, returning 34% year-to-date, following a 46% drop during 2011. The shares trade just below tangible book value, and for 9.5 times the consensus 2013 EPS estimate of $12.55. The company will announce its third-quarter results on Oct. 16, with a consensus EPS estimate of $2.12. Konrad's price target for Goldman's shares is $145, and the analyst on Thursday said that "despite a sluggish seasonal quarter, we expect Goldman to put up pretty solid results given the improvement in market values, relatively stable volatility and market share gains in its merger and acquisition business." The analyst raised his third-quarter operating EPS estimate for Goldman to $2.15 from $1.68.

KBW analyst Catherine Mealor on Thursday said that for regional and community banks, third-quarter themes include continued "favorable" overall loan growth, with "slowing commercial and industrial (C&I) growth," continuing pressure on net interest margins "being offset through additional duration/securities risk," and a continued boost to earnings, with loan loss "reserves heading toward normalized levels."

Moving past the "big four," and the large investment banks, KBW has "Outperform" ratings on 37 regional and smaller banking names. In order to feature some names that are "off the beaten path," we have isolated the five names with total assets of less than $5 billion as of June 30, with the greatest upside potential, based on KBW's price targets.

Here they are, ranked by ascending upside potential, based on the KBW price targets:

5. Heritage Financial
Shares of Heritage Financial ( HFWA) of Olympia, Wash., closed at $15.05 Friday, returning 22% year-to-date, following a 7% decline during 2011. Based on a regular quarterly payout of eight cents, the shares have a dividend yield of 2.13%.

The shares trade for 1.2 times tangible book value, according to Thomson Reuters Bank Insight, and for 16 times the consensus 2013 EPS estimate of 93 cents a share, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is 89 cents.

Heritage Financial had $1.4 billion in total assets as of June 30. For the 12-month period ended June 30, the company's operating return on average assets (ROA) was 0.85%, and its return on average tangible common equity (ROE) was 6.02%, according to Thomson Reuters Bank Insight. The relatively low ROE, when considering the decent ROA, reflects a high tangible common equity ratio of 14.0%, as of June 30.

One way that Heritage Financial has been putting its excess capital to work as been through common share repurchases. The company bought back 383,000 shares during the second quarter. In late August, Heritage Financial's board of directors authorized a new program to repurchase up to 5% of the company's common shares, or about 757,000 shares.

The company has also put its capital to work through acquisitions, purchasing two failed banks from the Federal Deposit Insurance Corp. in 2010. On Sept. 14, Heritage Financial announced a deal to acquire Northwest Commercial Bank ( NRTW) of Lakewood, Wash., for $3 million in cash. Northwest Commercial had $72.1 million in total assets as of June 30. As part of the merger, Heritage Financial will redeem the $2 million in preferred shares of Northwest Commercial held by the U.S. Treasury, for bailout assistance received through the Troubled Assets Relief Program, or TARP.

The consensus among analysts polled by Thomson Reuters is for Heritage Financial to report third-quarter earnings of 20 cents a share, declining from 21 cents in the second quarter, but increasing from 12 cents, during the third quarter of 2011.

KBW analyst Jacquelynne Chimera has an $18 price target for Heritage Financial, and in September called the Northwest Commercial deal a "relatively small" one, but said "we view it as a positive catalyst for the company as it highlights the bank as a disciplined participant in the consolidation wave that we expect to hit the Pacific Northwest."

In further comment about industry consolidation in the Pacific Northwest, Chimera said "we believe there are many banks in the PNW that are in situations similar to NCB, and that this is the tip of the iceberg for small-bank M&A in the region. There are approximately 80 banks in Oregon, Washington, and Idaho with assets of $500 million or less, and roughly one-third of these banks had an efficiency ratio of 90% or higher in 2Q12."

A bank's efficiency ratio is, essentially, the number of pennies of overhead expense it incurs for every dollar of revenue generated. Even for a profitable institution, a 90% efficiency ratio is lousy, and many inefficient community bank boards of directors may wish to get out while the getting is good, in the face ever-mounting regulatory compliance costs, narrowing spreads, and continuing loan quality concerns for some.

HFWA Chart HFWA data by YCharts

Interested in more on Heritage Financial? See TheStreet Ratings' report card for this stock.

4. Ameris Bancorp
Shares of Ameris Bancorp ( ABCB) of Moultrie, Ga., closed at $12.50 Friday, returning 22% year-to-date, following a 2.5% decline during 2011.

The shares trade for 1.2 times tangible book value, and for 12 times the consensus 2013 EPS estimate of $1.02. The consensus 2012 EPS estimate is 55 cents.

Ameris had $2.9 billion in total assets as of June 30. The company's ROA for the 12-month period ended June 30 was of 0.86% and its ROE was 8.81%.

The consensus among analysts is for the company to report third-quarter earnings of 14 cents, compared to 10 cents during the second quarter, and a 66 cents during the third quarter of 2011, when earnings were boosted by $26.9 million in gains from two FDIC-assisted acquisitions of failed banks.

The company completed nine failed-bank acquisitions from October 2009 through February of this year.

KBW analyst Brady Gailey has a $15 price target for Ameris, and said after his firm's community bank conference in August that the company has "worked diligently on improving its credit profile in recent quarters, allowing it to turn its focus toward earnings leverage and improved profitability in 2H12 and into 2013," and that "near term catalysts for the stock include: (1) accretive FDIC deals, (2) operating leverage from fee-based businesses, (3) further credit improvement, and (4) partial TARP repay."

The U.S. Treasury in June auctioned the $52 million in Ameris preferred stock it held, to private investors, for $47.7 million.

Second-quarter highlights for Ameris, according to Gailey, was an estimated "core" net interest margin of 4.20%, which is a high level for any community bank in the current rate environment, and 13% organic loan growth during the second-quarter, "most of which was from C&I and agricultural lending. Importantly, management believes this level of loan growth is sustainable on a net basis."

ABCB Chart ABCB data by YCharts

Interested in more on Ameris Bancorp? See TheStreet Ratings' report card for this stock.

3. OmniAmerican Bancorp
Shares of OmniAmerican Bancorp ( OABC) of Fort Worth, Texas, closed at $22.93 Friday, returning 46% year-to-date, following a 16% return during 2011.

The shares trade for 1.3 times tangible book value, and for 31 times the consensus 2013 EPS estimate of 75 cents. The consensus 2012 EPS estimate is 41 cents.

OmniAmerican Bancorp had $1.3 billion in total assets as of June 30. For the 12-month period ended June 30, the company's ROA was 0.33%, and its ROE was 2.58%.

The analyst consensus is for the company to report third-quarter earnings of eight cents a share, declining from 14 cents the previous quarter, and 10 cents, a year earlier.

OmniAmerican is included on KBW's "consolidation list" of potential acquisition targets.

KBW analyst Brady Gailey's price target for the shares is $28. The analyst said in late July, after OmniAmerican reported its second-quarter results, that "we continue to believe OABC's attractive franchise will be sought after by at least a handful of buyers," after the end of the three-year moratorium, following the company's conversion from mutual to stock ownership in January 2010.

OABC Chart OABC data by YCharts

Interested in more on OmniAmerican Bancorp? See TheStreet Ratings' report card for this stock.

2. Columbia Banking System
Shares of Columbia Banking System ( COLB) of Tacoma, Wash., closed at $18.76 Friday, returning 2% year-to-date, following a 7% decline during 2011. Based on a regular quarterly payout of nine cents, the shares have a dividend yield of 1.92%.

The shares trade for 1.2 times tangible book value, and for 13 times the consensus 2013 EPS estimate of $1.45. The consensus 2012 EPS estimate is $1.12.

Columbia Banking System had $4.8 billion in total assets at the end of the second quarter. For the 12-month period ended June 30, the company's ROA was 1.14%, and its ROE was 8.85%.

The analyst consensus is for the company to report third-quarter EPS of 30 cents, matching its second-quarter results, but declining from 48 cents during the third quarter of 2011, when the company booked a $1.8 million gain on its FDIC-assisted acquisition of Bank of Whitman.

On Sept. 26, the company announced an agreement to acquire West Coast Bancorp ( WCBO) of Lake Oswego, Ore., for about $506 million in cash and stock. West Coast Bancorp had $2.4 billion in total assets as of June 30.

Following the West Coast Bancorp deal announcement, KBW analyst Jacquelynne Chimera raised KBW's price target for Columbia Banking System by a dollar to $23, saying that "We view the deal positively given strong EPS accretion despite the issuance of additional shares, and believe the combined franchise will be a strong force in the Pacific Northwest."

Chimera said her "revised price target is based on a justified price-to-book calculation in which we have increased our long-term tangible ROA assumption to 1.35% from 1.10% previously," and that "the longer-term franchise is better served with the deal's structure despite the dilution to tangible book value that the market appeared to focus on given the decline in share price following the announcement."

COLB Chart COLB data by YCharts

Interested in more on Columbia Banking System? See TheStreet Ratings' report card for this stock.

1. Pacific Continental Corp.
Shares of Pacific Continental Corp. ( PCBK) of Eugene, Ore, closed at $9.13 Friday, returning 6% year-to-date, following an 11% decline during 2011. Based on a quarterly payout of 6 cents, the shares have a dividend yield of 2.63%.

The shares trade just above times tangible book value, and for 14 times the consensus 2013 EPS estimate of 67 cents. The consensus 2012 EPS estimate is 64 cents.

The company had $1.3 billion in total assets at the end of the second quarter. For the 12-month period ended June 30, Pacific Continental's ROA was 0.59%, and its ROE was 4.81%.

Following her firm's community bank conference in August, KBW analyst Jacquelynne Chimera said that Pacific Continental "is focused on growing in larger commercial markets given its business banking model," and was concentrating "its lending efforts on professionals and community businesses, while receiving its funding from nonprofit organizations and consumers/ business owners."

"The dental portfolio at Pacific Continental was 28.2% of the total book at 6/30, with 74% in market (51% Oregon / 23% Washington) and 26% out of market," Chimera said, adding that out-of-market loans "come from current, trusted, developed referral sources, and out-of-market loan generation goes through a great amount of scrutiny."

KBW's price target for Pacific Continental's shares is $12.00.

PCBK Chart PCBK data by YCharts

Interested in more on Pacific Continental Corp.? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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