Shares of Smithtown Bancorp tanked because the bank’s bad loans soared. By Elizabeth Leary, Contributing Editor February 4, 2010 We thought we’d found the perfect bank investment when we told you about the Bank of Smithtown. In 2008 and the first half of 2009, it appeared to have weathered the financial crisis all but unscathed. But as 2009 progressed, New York–area housing and commercial real estate markets soured, and the bank’s book of bum loans began to swell. Loans on which Smithtown wasn’t collecting payments reached 2.8% of its total loans at the end of the third quarter. That’s lower than the average among banks of similar size, but it represents a sixfold increase from the first quarter of 2009. As a result, Smithtown just broke even for the quarter. Since we recommended the stock (symbol SMTB), the shares have plunged 58%, to their recent price of $6, and the company has suspended dividend payments.How did we get it wrong? We failed to recognize that the bank’s buffer against bad loans was on the thin side, so the increase in nonperforming loans vaporized profits. But the stock’s plunge is out of proportion with the company’s loan problems. Smithtown isn’t a zombie bank with a black-hole balance sheet, and yet the stock currently sells for only six times estimated 2010 earnings of 90 cents per share and for just more than half its book value (even Citigroup is more richly valued). The bank’s deposit base -- its funding for future loans and future profits -- is still growing. And its chief executive is still the hands-on Brad Rock, who has lived through banking crises before. There will likely be a few more quarters of pain for Smithtown’s profits-and-loan book, but the stock will probably recover sooner. Hold on to your shares.