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Banking On a Mini Name

Tim Melvin

Naturally, the Baltimore Orioles lost to the New York Yankees on Monday, so our chances for a sweep of the series are gone. In spite of that, I have decided to take a peek into the microcap section of my bank stock portfolio and give you two local names that I own and have been involved with for years now. I had sold them both back in 2006 when the valuation pushed the upper end of what I could justify and have since repurchased the shares when bank stocks collapsed in the credit crisis. Both are located in Annapolis, Md. and both have the potential to recover along with the historically very strong local real estate markets.

Both of these banks are also really small and are not heavily traded, so please be careful trading these stocks. You need to be able to hold them for a long period of time as well. If something else goes wrong in the real estate markets or the overall economy, they will decline. Also, their less-than-liquid trading conditions will make it difficult to sell them at a reasonable price.

Today, I'll offer a closer look at Severn Bancorp SVBI . Severn is the holding company that owns Severn Savings Bank and several real estate related businesses. The bank is heavily leveraged to the local economy and currently operates under a consent order as a result of the large losses they experienced as the crisis deepened in 2008 and 2009. Severn is not allowed to pay dividends, issue debt or buy back stock without the approval of the Office of the Controller of the Currency and had to file plans with regulators outlining their plans to reduce problem assets and loans. The bank is making strides to improve the balance sheets as nonperforming loans peaked at over 10% of total assets in 2009 and were 5.7% at the end of 2011.

The real story with Severn Savings is the people who run it. Chairman Alan Hyatt first became involved with the bank when it was Pompeii Savings and was headquartered in a row house in Baltimore. He moved the bank to Annapolis and changed the name back in the 1990s. He is a real estate and banking attorney in Annapolis and is very well connected in the local community. He is not, however, as well connected as his father. Louis Hyatt opened his commercial real estate firm back in 1961 after a seven-year career as an agent for another firm in town. In the past 60 years, he has been involved in just about every major real estate transaction in the city of Annapolis. In 2009, he sold his real estate firm and it is now a subsidiary of the bank.

Severn is not a low-risk situation. It holds the bulk of its loans for investment and the portfolio will live and die with the local economy. It has substantial exposure to commercial as well as construction loans. In fact, 40% of its total loan portfolio is in these higher risk areas. The stock could face dilution from outstanding convertible preferred stock and warrants issued during the credit crisis. The bank currently has almost $20 million of foreclosed real estate on the books, which it will have to dispose of in a soft market. The bank still operates under that consent order. There is a lot that could go wrong for Severn Savings.

But there is a lot that could go right for the bank is well. When I look at the current board of directors, I see a list of long time Annapolitans with deep ties to the business community and the real estate markets. Annapolis is one of the strongest real estate markets in the country and has a heavy state and federal government presence. The history of the town and the location on the Chesapeake Bay make it an attractive area -- people want to live and work there. Ultimately, that point is going to boost for local real estate and economic conditions.

Obviously, Severn has far higher loan losses than I like to see in a bank of any size. However, it has a tangible equity to asset ratio of 13 and the shares trade at less than 40% of tangible book value. The Hyatt family owns 26% of the stock and has banking and real estate experience tracing back over half a century in the markets they serve. It is not risk free by any means, but I think it is a great bet on the Annapolis area and smart management.

On Wednesday, I will continue my look at my mighty mini stocks with another local bank.