Portfolio Manager Jay Kaplan describes the current environment for small-cap banks and why they could be an attractive investment opportunity.

Watch the video here.

Small-Cap Banks
Image source: Wikimedia Commons

Why Own Small-Cap Banks?

The environment for banking today I think is pretty good. Credit quality is very good, continues to get better, and if the economy stays on track it probably isn’t going to get much worse. And if the economy grows, demand for lending should grow.

With the new administration, with less regulation, that can take some of the handcuffs off banks. They ought to be able to lend more money more easily. They should be able to grow.

Interest rates are going up. That should be good for the profitability of small banks. The yield curve is steepening.

So, when you step back and think about the environment, the environment for small banking is pretty darn good.

What’s Your Current Outlook on Small-Cap Banks?

The fundamental outlook for the business of small community banking is really, really good. The fundamentals are good with the potential to get better. We still have far too many banks in America, so there will be merger and acquisition opportunities. We don’t buy stocks for that, but if that happens, even better. So, I think fundamentals are really, really good.

Valuations, which had been pretty inexpensive, are a little more in the fair range now. So, I think with a long-term time perspective, positions in small community banks can be accumulated, probably not with a big multiple expansion opportunity tomorrow.

But I think that the tailwinds of the fundamentals are really good, and that can provide a lot of runway for some long-term profits for folks who want to invest in small community banks.

Is It a Good Time To Invest in Small-Cap Banks?

In the current environment, I’ve been trimming back on some of the small-cap banks. I’m starting to add to some new ones. So, like everything else, you need to be selective. The market’s been very strong.

The market for small-cap banks has been very strong. So, I think it’s time for a pause. We don’t want to chase before fundamentals. We’ll get some earnings reports, and when we do, stocks will move around and I’ll be poised to take advantage of whatever opportunities should come up.

Article by Jay Kaplan, CFA – The Royce Funds