Banking analyst Michael L. Mayo believes he's found a good way of picking small banks that should be bought.

The secret? Figuring out which ones have cheap stock prices but a hefty franchise value.

The Lehman Brothers analyst spent six months digging into the guts of 152 small banks, using annual reports, conducting surveys, and gathering statistical data to determine their franchise value.

He came up with a hit list of 23 banks he says are undervalued and likely to be acquired, based on their low stock-price-to-franchise ratios.

"Generally speaking ... banks that trade at 80% to 85% of franchise value or less are often more vulnerable and historically the ones more likely to be taken over," Mr. Mayo said.

Shawmut National Corp., he noted, had a 69% price-to-franchise ratio shortly before Fleet Financial Corp. agreed to acquire the company in February. West One Bancorp's ratio was 81% before U.S. Bancorp agreed to acquire the Boise, Idaho, concern last month. And Los Angeles-based Metrobank's ratio was 61% before Comerica Inc. said it would acquire the company on May 4.

Who tops the list of 23 small banks?

Vermont Financial Services Corp. ranks No. 1, with a stock-price-to- franchise ratio of 58%.

"They have better than average pension and health care funding, excess reserves, and a higher than usual level of fee activities, including mortgage trust and credit cards," Mr. Mayo said.

It is followed by CPB Inc., a $1.4 billion-asset company in Honolulu, with a 65% ratio, and by Chittenden Trust Co. of Burlington, Vt., with a ratio of 70%.

Mr. Mayo believes franchise value is important during this period of bank consolidation. He said much of the industry's $100 billion in excess capital will be used for takeovers.

"Book values don't tell the whole story," Mr. Mayo said.

The survey, an exhaustive piece of work that was released in May, breaks down certain assets of 152 institutions and assigns them values that are computed into the franchise value.

Mr. Mayo constructed the small-bank franchise model by marking to market 13 on- and off-balance-sheet items, including mortgage loans serviced, credit cards, trust operations, even health and pension plans.

The 13 "hidden assets" were then assigned values based on estimated fair market values.

Marking to market such assets as pension plans, mutual funds, and money managers was a painstaking task that required dipping into a variety of sources. Mr. Mayo spent three months just working on the concept of franchise value before he began the study, he said.

In valuing core deposits, for example, he awarded banks premiums ranging from 4% to 8%, based on market share, cost of deposits, and strength of the local economy. To determine the strength of an economy, he drew from the Allied Van Lines index, which tracks the number of domestic interstate household good relocations year to year. Allied is a Naperville, Ill.-based relocation firm. A bank with a low cost of funds, a sizzling market, and a dominant position received a higher premium.

"This is a monumental task," said Elizabeth Summers, a banking analyst with Ryan Beck & Co., West Orange, N.J.

Ms. Summers said that many analysts rely heavily on data from SNL Securities, a Charlottesville, Va.-based research and bank information firm, and don't do as much in-depth work because of time constraints.

"What impressed me is that they pulled in from a variety of sources," she said. "They have tried to quantify the impact over various lines of business."

Reactions to the study, however, were mixed.

John D. Hashagen, president and chief executive of Vermont Financial, was impressed by the work but isn't sure the company's top ranking means anything as far as its future is concerned.

"I don't know that I would say we are specifically a target any more than anybody else these days," he said.

Ms. Summers noted that the study is a "great starting point," but not perfect.

"If you look hard enough, you are going to find mistakes," she said.

She said that about a week after the study came out Meridian Bancorp said it would acquire United Counties Bancorp. United was listed as a high performer but was not on the list of 23.

Mr. Mayo agrees that the work is not foolproof.

"In general, the missing ingredient in the franchise value approach is management," he said. "The model will not show who has a superior management and who has an inferior management."

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