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Shrinking Banks, Expensive Liquidity And The Blues

Shrinking Banks, Expensive Liquidity And The Blues

This piece contains the opinions of deep value investor Tim Melvin that do not reflect the opinions of

I had a nice discussion earlier this week with the former CEO of Bryn Mawr Bank Corp. (NASDAQ: BMTC) earlier this week.

Under the leadership of Ted Peters, Bryn Mawr has been a consistently high performing bank and even in the financial crisis the stock more than held its own.

He made his shareholders a ton of money over the years and now he is turning his eyes towards making investors a bunch of money. Mr. Peters has just opened a new hedge fund, Bluestone Financial Institutions Fund, which will invest in community banks.

In our discussion he told me that banks are well positioned to offer high returns over the next few years. The smaller banks are well capitalized and are one of the few institutions that will benefit from higher rates.

As I have pointed out many times he also cites the fact that M&A activity is picking up. He thinks that over the next five years or so we will go from about 6700 banks today to about 4500 banks. After we saw 272 bank deals in 2014, Mr. Peters said that most observers see as many as 350 this year. This represents an enormous opportunity but most of the folks I talk with are not involved in the sector.

Stocks Are Just Too Illiquid

I don't want to bust anyone's bubble here but the vast majority of folks are not going to be traders of great renown and profit. You do not need that kind of instant liquidity. I have the pleasure of knowing some great traders. Some of these folks have built enormous fortunes engaging in the short term trading of stocks and futures.

Interestingly most of them have some traits in common the most prevalent being a deep understanding of and affection for higher mathematics and statistics. Some of them are literally rocket scientists. All of them work very hard and are constantly updating their methods and systems to adjust for ever changing cycles and market conditions.

14-16 hours a day are not unheard of when markets are volatile. Most of them are very well capitalized and mentally and emotionally prepared to deal with drawdowns. They are the exceptional people that are the exception not the norm.

Those of us without the advanced math degrees who have other careers as well as family obligations, hobbies, interests and concerns are never going to compete with them. The notion that you are going to draw a few lines on a chart in the evenings and compete with these guys is akin to me deeming myself ready to start in center field for the Orioles this season.

I would love it but it is never going to happen. I simply do not possess the required skill set. I don't need to go out and get a new mitt and you don't need as much liquidity as you think you do.

Your Desire To Fire Off Orders To Enter And Exit Stocks In Milliseconds Is Costing You Money

Lots of it in fact. Roger G. Ibbotson of Yale published a paper titled "Liquidity as an Investment Style." He looked at stocks based on liquidity from 1972 to 2011.

He found that illiquid stocks outperformed liquid ones by a significant margin. He found that "Among the high growth stocks, the low-liquidity stock portfolio had an annualized geometric mean (compound) return of 9.99% whereas the high-liquidity stock portfolio had a return of 2.24%. Among the high-value stocks, low-liquidity stocks had an 18.43% return whereas high-turnover stocks had a return of 9.98%."

Where do most folks spend all their time and money whipping in and out of the market? The high growth high profile growth stocks that dramatically underperform. What is the very definition of a high value low liquidity stock that offers the very best returns? A community bank stock with a solid loan portfolio and plenty of capital purchased below book value.

Song of the week. If you don't get involved in the community banks, its gonna be:

Tags: Roger G. Ibbotson Ted Peters

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