Analyzing and Investing in Community Bank Stocks

ANALYZING AND INVESTING IN COMMUNITY BANK STOCKS David B. Moore ANALYZING AND INVESTING IN COMMUNITY BANK STOCKS David B. Moore Icarus Publishing Copyright © 2005 by David B. Moore All rights reserved under International and Pan-American Copyright Conventions. CONTENTS Introduction & Acknowledgements Chapter 1: Introduction to Banks and Bank Investing 1 Chapter 2: The Balance Sheet 9 Appendix I: Common Borrowing Arrangements 17 Appendix I: Trust Prefered Securities 23 Chapter 3: The Income Statement 25 Chapter 4: Aset/Liability Structure 35 Chapter 5: Asset Quality and Reserve Coverage 43 Appendix III: Asset Quality and Economic Cycles 52 Chapter 6: Acounting Shenanigans 5 Appendix IV: Gain on Sale Accounting – A Primer 63 Chapter 7: Regulatory Environment 69 Appendix V: A Brief

History of Major Banking Legislation 76 Chapter 8: Bank Acquisitions 101 81 Appendix VI: Understanding Reflexivity 98 Chapter 9: Valuing Bank Stocks 101 Appendix VII: A Valuation Conundrum – Book Value vs. Earnings 124 Chapter 10: Common Investment Strategies 127 Chapter 11: Case Studies 143 Research Reports: Community First Bankshares, Inc. CNB Bancshares, Inc. Hamilton Bancorp, Inc. Appendix VIII: The Savings & Loan Crisis 205 Glossary of Terms 209 Footnotes 221 References 225 About the Author 227 INTRODUCTION & ACKNOWLEDGEMENTS Although the audience for a book on investing in community bank stocks is limited by the very nature of its somewhat narrow and obscure subject matter, I decided to write one anyway. Why? Clearly I’m a glutton for punishment. To describe community bank analysis as a dry topic would be an understatement, to say the least. So, with that said, let me address a few issues about the book itself. First, this is a book about community banks and thrifts, which I define as those depositories with less than $15 billion in assets. If you want to know more about how to analyze larger banks like Bank of America, JP Morgan or Northern Trust, you’re reading the wrong book. Second, use of the terms “bank,” “institution” and “depository” throughout this book also refers to thrifts (that is, Savings & Loans), unless specifically noted to the contrary. Third, almost all of the italicized terms – where italics are not used for emphasis – are either defined in the text or in the glossary. Finally, you will notice that there is no chapter on a bank’s statement of cash flows. While all banks, obviously, have a cash flow statement, I chose not to spend any time on this subject. Unlike most industrial companies, banks don’t have meaningful amounts of depreciation and short-term receivables. Consequently, unless a bank is engaging in accounting shenanigans (as addressed in Chapter 6), its net income should be a close approximation of its operating cash flow. And there’s no great mystery about a bank’s investment and financing cash flows. So, rather than having a two-page chapter explaining the obvious, I just left analysis of the cash flow statement out of the book altogether. I encourage you to read the footnotes. I actually have little pride of authorship where specific ideas are concerned. In many respects, this book is a compilation of both my thoughts (primarily) and those of...

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