Bank of Marin (BMRC 0.04%) is a small commercial and retail bank in the San Francisco Bay Area. With $2 billion in assets, it mostly serves small and medium-size businesses in Marin, San Francisco, and Alameda counties. These businesses are reliant on the health of the Bay Area economy, which mainly revolves around the technology industry.
However, Bank of Marin's main operational area, Marin, is much more low-tech. Because the bank lends mainly to local businesses like furniture makers, wineries, and construction companies, it is insulated from a lot of the boom-and-bust cycle of the tech industry.
Increased government spending means more loans
Since the day after the elections, financial stocks have shot up. Banks in particular are trading at elevated valuations compared to just weeks earlier. Much of this has to do with President-elect Trump's policies, which could drastically increase the national debt. President Obama and presidential candidate Hillary Clinton proposed similar programs, but the chance of their passage was negligible with Republicans in charge of the House and Senate.
Now that divided government is a thing of the past, the potential for expansionary spending has increased drastically. Large spending programs can help jump-start the economy. A spark of spending provided by the federal government can increase economic activity in the entire economy if the right conditions are present.
Banks are in the perfect position to benefit from this influx of new money. Every time a company gets paid for a project, it puts the money in a bank account. That allows banks to make more loans, which are needed to finance other projects. Because banks deal in money as their primary product, fiscal stimulus will always increase their ability to fund more loans.
More inflation means more interest income
With unemployment low (below 5%), this government-funded economic activity results in higher wages and inflation. Banks benefit from this inflation because of higher interest rates on loans.
No doubt banks will have to raise their deposit rates to compete for the new money, but they are usually able to increase their home and commercial loan rates even more. This usually results in an increase in net interest margin, the primary measure of loan profitability. Here's what Bank of Marin's net interest margin has looked like over the past 10 years:
Here 2016 is represented by only nine months' worth of data, but a potential increase of interest rates can already be seen. After a decrease from 5% to 4% over the past five years, Bank of Marin investors are thinking net interest margin may increase in the future.
The years since the Great Recession have seen the banking industry become much more stable. Growth has been slow, but many banks have improved their balance sheets by removing the bad debt that fed the financial collapse. Bad banks have become better and good banks have become great. Bank of Marin is one of these great banks.
Excellent asset quality
Prior to the recession, Bank of Marin had an excellent loan approval process. This resulted in an extremely low percentage of non-performing loans, or NPL. As I recently explained in an article on Bank of the Sierra, another small California bank, NPL percentage can be used to judge a bank's asset quality. Low percentages of NPLs indicate high-quality assets, and, by extension, a good loan approval process. Bank of Marin had that in spades:
During and after the recession, NPLs did increase, but stayed below the 2% mark. I've put a line at 1% since that's a good benchmark to watch for any bank. Bank of Marin never strayed far above 1%, and is now quite far below it. The current low level is probably due partially to timing and luck, but only the best-run banks can reach levels this low with mature loans, so Bank of Marin has clearly done a good job in this area.
This excellent loan quality makes Bank of Marin a potential takeover target by larger banks or private equity firms. A good balance sheet minimizes the due diligence risk to the deal. It also increases the chance of an acquisition performing well as a part of the new company. A good combination of long-term internal and short-term external factors has caused investors to see Bank of Marin for what it always was: a relatively safe play on a vibrant local economy with acquisition possibilities.
