Community bank stocks have been strong performers, spurred by takeover speculation, but the companies face important questions about their future.
"The franchise value of community banks is being challenged on multiple fronts," according to analysts for Alex. Brown & Sons Inc., Baltimore, which last week held an investment seminar on the banks.
Smaller banks in general have lost their profitability edge over larger banks because they enjoy less fee income and fewer economies of scale, the analysts said.
Meanwhile, many such banks' branch networks, a key part of their franchises, will likely fall in value to potential buyers as development moves ahead on alternative delivery systems for financial services.
The situation has been met head-on by some managers.
"We put a stop to the debate about whether we were running things with the idea of being acquired or the idea of staying independent," said E. Rhone Sasser, chairman and chief executive officer of United Carolina Bancshares, Whiteville, N.C.
"I don't know what the future may bring, but we are operating our bank on the premise of remaining independent and achieving the best results we can," he told the seminar in New York.
Because of their strong stock performance, the Alex. Brown analysts said, they believe "the average community bank stock valuation is ahead of fundamentals, particularly relative to larger regional banks."
They currently have a "strong buy" rating on only one such company. That is Cullen/Frost Bankers Inc., San Antonio.
Community bank stock prices have been powered by healthy takeover premiums paid in recent years for such banks located in affluent markets.
In New Jersey last year, National Westminster Bank paid 2.4 times book value for Citizens First Bancorp and 2.3 times book for Central Jersey Bancorp.
In the Chicago area, Firstar Corp. paid twice reported book value, and 2.6 times tangible book value, for First Colonial Bankshares, while Harris Bancorp. paid 2.4 times book for Suburban Bancorp.
Community banks' stocks did well last year amid rising interest rates, gaining 7.5% on average, compared to a 0.7% drop in regional banks followed by Alex. Brown and a 1.5% decline in the Standard & Poor's 500 stock index.
In the first quarter this year, community banks rose another 7.2%, as regionals banks gained 15.4%, buoyed by stable rates. Other stocks rose 9%.
The analysts Mark Alpert, George A. Bicher, and Joseph K. Morford emphasized that they believe investment opportunities remain in the small bank sector, and they said they feel many such banks "have valuable and unique franchises."
The most attractive, they said, are banks that are dominant in their markets, "and if the market is growing, so much the better."
Besides Cullen/Frost, they include in this category Texas Regional Bancshares, McAllen, Tex., and First Commercial Corp., Little Rock. Both get "buy" ratings.
Community banks in affluent or strong-growth markets with no dominant institutions may also rank as good investments, they said. Among such banks they have a "buy" rating on State Bancshares, Philadelphia.
And there are banks with highly specialized or "niche" franchises. As examples, they cited Silicon Valley Bancshares, San Jose, Calif., and Mark Twain Bancshares, St. Louis.