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Atna Resources: Why I haven’t sold a share

A couple of weeks ago Gecko Research (which seems to be, oddly enough, a Swedish based, Canadian Gold junior company research firm) put out a report on Atna Resources.  The report is available here.

Most of the report is full of your typical fare.  These are their properties, this is their management, yada, yada, yada.

Then I got to this table:

I did a double take when I looked at the 2013-2016 cash flow numbers.  $1 per share in 2013?  Is that possible?  Could Atna really generate that much cash flow that quickly?

The work I have done

When I looked at the table and contemplated the numbers it occured to me that I had never actually looked at the year by year cash flow that the company might generate once Pinson is up and running.  What I spent quite a long time looking at was the net asset value of the company.  I did that analysis right before Christmas.

What I found out was this:

After I came up with the NAV estimates I basically wrapped up my analysis  and put it under the Christmas tree.

See, I don’t have oodles of time to do miscellaneous research.  When I get a set of numbers like the one’s in the table above, where the only conclusion that can be drawn is table pounding buy, I don’t tend to spend too much more time splicing out the details.  Atna is going to make a lot of money and that is not baked into the price of the stock.  End of story.  Go buy the stock.

Anyways that was my thinking at the time.  So I never really looked at the year by year cash flow in any detail.  Until I read the Gecko report and that made me curious.  Could it really be that high?

Looking at cash flow

The best way to check the numbers is to run them yourself.  I took the inputs Gecko provided and created my own little cash flow spreadsheet.

The first thing that should be pointed out is that Gecko is using, to put it mildly, optimistic gold prices.  I don’t think there are any analysts out there using $2600 per ounce gold for 2016.

Second, I had to make some assumptions. For D&A I assumed a constant $200/oz produced which I think is likely going to be on the high side.  For G&A I used $8M per year, which was based off of the average of what I saw from some other companies (Argonaut, Aurizon, Allied-Nevada, Alamos), and no I did not intend to only compare the company against other companies that started with the letter A.

Exploration was assumed to $10M per year, which may be on the high side but Atna has a lot of other properties so I wouldn’t be surprised if they start working on them once they have the cash.

Taxes are based on the nominal rate provided by the company.

The results I came up with were not too far off what Gecko did.

And using the BMO price deck…

Since I had the spreadsheet built I started to look at other scenarios.  Probably the most illustrative was to look at what Atna might be generating based on the BMO price deck.   The BMO price deck could be considered to be a “realistic” price deck, with the term realistic being defined as generally accepted until it is proven to be horribly wrong.

But that is for another rant.

BMO is predicting the following gold price going forward:

You still get some pretty gaudy cash flow numbers:

Financing?

Another point that was brought up in the Gecko report was the chance of a financing.  Gecko thinks this is going to happen.  I hadn’t really thought about the possibility too much until they brought it up, but I can see the logic.

Even though Atna has the possibility to grow only from internal cash flow, we think that Atna will raise money through an equity financing some time during H1/12, likely during Q1. We believe C$20 million will be sufficient to take Atna through 2012 with the development of Pinson and to fast track the studies of Pinson Open pit. This will also assure that long lead-time equipment for the Reward Mine will be ordered in time. We assume an equity raise will be done at C$1.50 by issuing 13.33 million shares.

It’s a fair point.  While they can probably squeeze by without one, they don’t have much cushion.  As long as its done at a high enough price, I have no problem with it

Haven’t sold a share

Over the past month Atna has gotten its butt kicked along with the rest of the gold sector.  It probably went too high too fast and now its come back to earth.

I don’t love gold right now. With the economy improving I can imagine that selling pressure will remain on the metal.  My favorite sector right now, the regional banks, are the antithesis of gold.  Its hard to imagine both going up together.

Yet I haven’t sold a single share of Atna.  I bought more shares when it dropped into the $1.12-$1.15 range late last week.  I don’t really expect much upward pressure on the shares until they begin to announce more news about Pinson.  In particular I think the full permitting of the project would be big news.

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Week 38: Waiting on a move

Portfolio Performance

Portfolio Composition

Portfolio Trades

So first of all . . . .

I don’t know what happened with the AUM trade

I think there is a gliche with the RBC Practice Account because somehow I sold Golden Minerals (AUM) on Wednesday and ended up with a long AUM in Canadian dollars and a short AUM for the same amount of shares in US dollars on Thursday.  I am hoping the trade resolves itself (in my actual accounts this sort of matched trade in the wrong currency would automatically resolve) but if it doesn’t I will attempt to clean it up myself.  I wanted to point it out because my current portfolio composition looks a little odd as a result.

Buy more banks . . . .

I’m still buying financials and I am actively looking for more to buy.  I got a few more ideas from a new website that I have signed up to called stocktwits (its like twitter for stocks).  The names are: ORRF, FFNW, SNBC, and GBNK.  I haven’t done enough research on any of these names to make an assessment of them.

This week I added to both Shore Bancshares and to Rurban Financial.  I looked at both in more detail this weekend and I am happy with what I see.  I’ll try to put together a post on each shortly.  I’ve already seen a double in Community Bankers Trust, and I’m up 40% since my original purchase of Bank of Commerce Holdings but I have no plans to sell either.

This week I also noticed that one of the banks I held but sold, Xenith Bankshares, popped.  I may buy that one on weakness.  I’m also watching the newswire for anything on Atlantic Coast Financial.  ACFC has a brutal loan book and could very well kick the can at some point, but the stock also has a book value of over $19 (yes that is right, it is a $2 stock with a $19 book value) so it is imaginable that if the banks continue to be on fire the stock could move up rather substantially.

. . . .Less oil

I sold out of Arcan Resources this week.

Why did I sell? Three reasons.

  1. The company ran into some operational problems (again) that cut back production for a time
  2. Spring break up is upon us and while I’m not certain of the extent that Arcan is impacted I do know that the junior oil investment community tends to go on leave from April until June.
  3. I want to put my money in the best opportunities and right now the best opportunity is in the regional and community banks and in the mortgage servicers.

Maybe I am selling at the bottom.  I’m sure there are a few that would scoff at me selling after a 20% drop.  Stupid retail.  So be it.  The banks are going up right now and Arcan is not.  So I would rather own the banks.

To give you a taste of just how impressive the bank performance has been, consider these charts:

A couple new positions

I also have initiated a couple of new positions that I consider myself “restricted” in talking about, at least for the time being.  The first is Cal-Maine Foods, which is a large egg producer.  If you want to get an idea of my reasons behind the purchase, take a look at my recent tweets ( I also signed up for Twitter this week).

A second position that I started was Golden Standard Ventures.  Golden Standard is drilling in Nevada and they may have hit gold in the way of a Carline style deposit.  A real spec here, but one that from what I hear has a reasonable chance of working.

Pounding the table on Mortgage Servicing Rights

In my opinion mortgage servicing rights (MSR’s) are the best opportunity in the market right now. The potential is there for returns as much as 30-40% IRR for the companies involved. The companies involved are not trading at premiums that reflect this, and in some cases they are trading at discounts to the market (PHH) or with extremely attractive dividends (Newcastle).

I believe the opportunity is being ignored by a market for three reasons:

  1. The market lumps MSRs in as just another housing play, and housing is still 2-3 years away from recovering
  2. MSR’s are complicated and most market participants don’t want to take the time to understand them
  3. MSR’s have traditionally been a crappy business and over the past 5 years they have been a really crappy business

In order to consistently beat the market I have learned that I have to look for value in typically crappy businesses and be willing to learn complex and sometimes opaque things.  When I started investing I knew nothing about oil and gas.  A few years ago I knew nothing about potash.  A couple of years ago I knew nothing about the pulp industry.  A year ago I knew nothing about regional banking.  And two months ago I knew nothing about mortgage servicing rights.

I continue to go wherever my nose takes me.  And right now it has lead me straight to mortgage servicing rights.

What is a mortgage servicing right?

A mortgage servicing right (MSR) is a list of conditions and responsibilities that are completed in return for a payment.

I’m going to simplify the details, but essentially here is how it works.  When a mortgage company originates a loan, along with the note that binds the borrower to making payments, they get a right to a tiny sliver of interest that will be paid in return for making sure that the money gets from the borrower to the lender (along with some other responsibilities, most of which deal with what happens in the case of delinquency).  Usually this sliver of interest is around 25-50 basis points.  For example, for a loan for $200,000 will include the right to receive $250-$500 a year in return for making sure that the money gets collected from the borrower (among other responsibilities).

Its that sliver of interest that is paid in return for the collection and other servicing duties that is called the Mortgage Servicing Right.

As a mortgage originator you have two choices of what to do with the mortgage servicing right.  You can keep it, in which case you will collect the sliver of interest from now until the mortgage is either  paid off or defaults.  Or you can sell it to someone else in return for cash up front.

Traditionally it has been the preference of small originators to sell the MSR for cash up front. Origination is a cash heavy business and managing cash flow is key.  So while it might be nice to have a steady monthly income flowing in from the MSR, typically the more immediate concern is getting cash on the books right now.

When the originator sells the MSR up front they receive a servicing release premium (SRP).  This sounds like a complicated term but its not.  All a SRP is, is a lump sum payment that is paid in return for the stream of cash flows from the MSR that you are giving up.

If you are interested in an even more detailed explanation of a MSR, there was an excellent discussion paper put out by the FHFA that is accessible here.

The collapse of the SRP

Of course, to make it worth your while to sell the MSR you need to get a decent amount of cash up front for it.  Traditionally SRP’s have fetched in the neighborhood of 4x to 6x the underlying MSR yearly payment.  Going back to our theoretical mortgage above, if you were receiving $250 a year from the MSR, you might have expected to fetch $1000 (or maybe even $1500 if you are lucky) up front for that income stream.  To the buyer of the SRP it would become a good deal if the mortgage didn’t go into default or get repaid for more than 4 years.  After 4 years they get their money back, and every year after that they get incremental return.  For you as the cash strapped originator that needs to pay your employees and keep yourself liquid to make further originations, the $1000 up front helps you stay afloat and generate further originations.

A little over a month ago I wrote about a great discussion on the Lykken on Lending mortgage banking podcast.  Lykken had Austin Tilghman and David Stephens, CEO & CFO respectfully of United Capital Markets, on the program for an interview.  These fellows are industry experts in the mortgage servicing market.  The discussion begins about a half hour into the podcast.   Here is a particularly relevant comment from Stephens on the current state of the SRP market:

Prior to the meltdown the price paid for an SRP [servicing release premium] was generally 5x or more of the [mortgage] service fee.  That multiple dropped to 4x a few years ago and we are hearing that its dropped to 0x in some cases today.

This comment was followed up by Andy Schell, a co-host on the broadcast.  Schell said that he had recently done an analysis of SRP’s and MSR’s and, in his words, “I couldn’t believe the numbers are so low.”  He reiterated that the SRP’s are in some cases approaching zero.

As an originator, maybe it made sense to sell the MSR in return for a SRP that was 4x or 5x as much as you would get from the MSR in the first year.  But now you are looking at a SRP that is approaching 0 in some cases.  Even in the case of strong originations (good quality loans with low default rates) you aren’t going to get more than 2x the MSR’s yearly return, and are probably going to get somewhere between 1x and 2x.

It doesn’t make as much sense.

Take our example: would you give up an income stream of $250 a year if you were only going to get $350 or at best $500 for it?  If you held it instead you could return double that amount in only 4 years?

Who is selling MSRs at these bargain basement prices?

I think that there are two reasons that MSR’s are getting sold down to such low prices:

  1. The big banks are getting out of the business
  2. The little guys have difficulty getting into the business

The big banks

There are a couple of things going on with the big banks.  First of all,  there are regulatory capital changes about to take place that are going to effect how much capital a bank has to keep on its books to hold an MSR.  Under Basil III requirement of how much capital must be held for an MSE changes dramatically:

One of the biggest changes in capital definitions for U.S. banks involves mortgage servicing rights (MSR). Under Basel III, banks will be allowed to include only a maximum 10% of MSR in their capital measures. Any amount above that is deducted; and then, in combination with financial holdings and deferred tax assets (DTA), that can only be up to 15% of aggregate capital. In contrast, under current rules MSRs are included in capital up to 90% of fair value or book value, whichever is lower.

The second reason is simply the consolidation of the banking industry.  Again referring to David Stephens:

Its the aggregation of the aggregators.  In 2007 an originator might have 20 take outs for the loan they produced.  After the spectacular failures of 2008 and the combination of large companies into even larger ones there may have been 10 takeouts.  Recently we’ve seen BoA and Citi getting out of the market and you can count on one hand the number of people that account for 50% of the market.  And they have their own capacity limitations.  It just gets tougher and tougher to find a takeout and then those that are left are becoming more selective about what they buy.

A third reason that the banks want out of the business is the way that MSR’s are accounted for.  The GAAP accounting standards for MSR’s forces banks to account for them on a mark to market basis.  This means that a bank has to revise the value of the MSR every quarter.  The nature of the MSR is that it is going to be extremely sensitive to interest rates.  If interest rates go down then more borrowers are going to look to refinance their mortgage.  When a mortgage is refinanced the existing mortgage is paid off and the MSR that is tied to the existing mortgage stops paying interest.  So as interest rates go down the probability of prepayment increases, bringing the value of the existing MSR’s on the books down.

Banks have been writing down MSR’s for a number of years now as the Fed does everything in its power to lower interest rates.  They are sick of having to book quarterly writedowns on the MSR assets.  In addition, they have been booking further writedowns because so many mortgages have gone into default over the past 5 years.  If you add to those factors the stigma of being involved too heavily with the mortgage business, you can see why so many banks are either getting out of the business entirely (Bank of America) or scaling back on the business considerably (Citi and JP Morgan).

And there you have it.  A simple supply and demand imbalance where demand for SRP’s has been decimated by the housing collapse have caused a disconnect in servicing valuations.

The little guys

The reason that more originators aren’t keeping the MSR on their books is simple.

  1. They need the cash up front and they can’t wait a couple of years to recoup it
  2. They don’t have the cash to make the start-up investments to get into the business

We are in a period where originations are strong because of the strong refinancing activity that has been brought about by low interest rates.  This creates more pressure on the smaller originators to sell their MSR’s and realize the cash up front.  Meanwhile the drop in SRPs creates what is almost a snowball effect.  Getting less cash for the MSR’s you sell precipitates the need to sell more of your MSR’s in order to meet your cash needs.

It is also not an easy process to get approved as a servicer if you are an originator that has traditionally sold off your MSRs but you want to begin holding them on your books.  According to Tilghman:

Its not an easy process.  Some started the process a couple of years ago, had their approvals in place for this market opportunity.  It is daunting though… there is a huge backlog at Ginnie Mae and at the GSE’s… the people we talk to says this is still incredibly slow and its taking months for companies to get approvals.  We talked to one subservicer and he as 20 companies waiting for approvals. And frankly we are talking to 30 companies that 6 months ago weren’t interest in owning MSRs and are now looking to get approvals. 

Selling at the bottom

The irony is that all this selling is taking a place at a time when underwriting standards have never been better.

The quality of the servicing has never been better, low interest rates, tough underwriting, good appraisals, those are the positives.  A lot of potential for the servicing to gain value in the future when rates go up, but most importantly to have it in place when rates go up as a hedge against your production dropping maybe 80%.

As the servicer of a mortgage, there are 3 things you don’t want to see:

  1. The house get sold
  2. The loan get refinanced
  3. The borrower defaults on the loan

There isn’t much that can be done about number one.  But two and three are functions of the market and of loan quality, and they are notably strong right now.

Interest rates are probably as low as they are going to get.  This has led to the boom in housing refinancing that I mentioned earlier.  The refinancing boom has been a hit to servicers who have seen their MSR’s stop paying out when the house gets refinanced.  The upside of this is that the new loans being put on the books are unlikely to be refinanced for some time.  Rates are more likely to go up than down.  The opportunity is there to realize servicing revenues on new loans for a significant period time.

Banks were hit hard when subprime borrowers walked away from their homes.  Because loans weren’t getting paid, neither were the servicing fee.  Compounding the problem, servicing rights often have clauses whereby the servicer incurs additional responsibilities when the borrower goes into the foreclosure chain.

Now we have the opposite scenario.  Lending standards are so tight that only the most fool-proof borrowers are able to get loans.  The risk of default should be greatly reduced.  The result again is for the MSR to stay on the books, paying out cash, for longer.

The risk of regulation

The main risk to the thesis that I see is regulation.  There was a lot of concern that that the FHFA was going to change the servicing model for agency servicing model, either by reducing the fee that a servicer received or by changing the structure to a fixed fee that was independent on loan value.  The FHFA put out a talking paper to talk about the proposed changes back in September of last year.

In its talking paper, FHFA once again floats the idea of paying a set dollar amount for servicing loans, while keeping open to the idea of maintaining a minimum servicing fee model similar to the current structure, but one with a reserve account option. “The reserve account would be available to offset unexpectedly high servicing costs resulting from extraordinary deteriorations in industry conditions,” the talking paper notes.

There was a lot of resistance against the proposed ideas, particularly from the smaller servicers, who said that the reduced servicing premium would basically squeeze them out of the business. The FHFA recently stepped back from the proposals, but they have yet to put an end to the discussion completely.  Tilghman said the following about the matter:

We are continuing to be disturbed that the FHFA refuses to clearly state the servicing compensation issue that it is off the table.  The responses to their December proposal were 80% against any change or for a moderate change and yet they will not acknowledge that and continue to leave open the potential for that issue.  If they understood the markets and were serious about competition well frankly that is going on as we speak, they’d provide certainty and they would kill the issues that have no substantive support. 

How to invest

Finding companies to take advantage of the opportunity hasn’t been easy.  The two obvious one’s that I have owned since the start are Newcastle Financial (whichI have written about here) and PHH Corporation (which I have written about here).

There are also a couple of new IPO’s for companies looking to take advantage of the opportunity.  Both Nationstar Mortgage Holdings (NSM) and Home Loan Servicing Solutions (HLSS) have had IPO’s in the last month

Nationstar is a well established servicer that had been held by Fortress Investment Group (FIG). Nationstar looks to be in the same vein as PHH; an originator with a large servicing business. Nationstar also has a large subservicing business, which means that they take on the servicing responsibilities for servicing rights held by other companies in return for a fee.

Fortress Investment Group is also an interesting idea. FIG owns about 80% of Nationstar. That puts FIG’s investment in Nationstar at a value of about $900M. If you look at FIG, the stock is at $3.75 right now and fully diluted Class A and Class B shares are a little less than 500M. So just roughly here, FIG has a market capitalization of $1.875B, meaning that Nationstar alone is worth half the market cap. FIG has about $43B in total assets under management so in the grand scheme of things Nationstar shouldn’t be that big of a part of FIG.

It’s a situation that brings up your spidey senses. Is the value of Nationstar sneaking in under the radar of FIG shares? The problem is that I can’t be sure yet. I am looking at FIG right now and it’s a tough slog; its difficult to get the details about what they actually own and what the value actually is because of the nature of their corporation of funds structure. You can do a search through the 10-K and the name Nationstar isn’t mentioned once. But I’m going to keep investigating. FIG smells to me like one of those 5-bagger opportunities, but I just don’t understand the company enough yet to say for sure.

Finally, Home Loan Servicing Solutions is a spin-off of Ocwen Financial. Having read the prospectus, it appears that HLSS will be a income vehicle. They are going to buy up the MSR’s currently on Ocwen’s books in return for a portion of the servicing fee. Ocwen would still do the servicing on the mortgages (acting in the capacity of subservicer) and in return they would be paid a base fee plus an incentive fee that is structured to entice Ocwen to keep as many of the borrowers current as possible.

It’s a similar sort of deal to what Newcastle and Nationstar are doing. Its structured a bit different, with the main difference being because the loans involved are subprime and not agency. Servicing subprime loans has an extra aspect that doesn’t occur with agency loans. When you are dealing with subprime loans, the servicer is responsible for putting up money in the short term when the payments are late. This means that the servicer has to have access to a credit facility, (or some other sort of funding) that they can borrow from when they need to cover payments. And that funding costs you in interest.

Now admittedly my understanding on this isn’t completely clear yet, but from what I’ve read I don’t think the servicer is ultimately on the line for payments they put up. They are eventually reimbursed, either from the borrower when the payment is made, or from other payments in the pool if the mortgage goes into foreclosure and the payment will never be made. But they do have to put up cash in the interim.

So along with the servicing commitments, HLSS is taking over a number of credit facilities that had previously belonged to Ocwen. In this case they are commercial paper facilities, and they provide access to the short term credit that HLSS needs to have so it can cover any late payments to the pool. HLSS has to pay the interest on these facilities and that comes out of their profits

So that’s the downside of a subprime deal versus an agency deal. The upside of a subprime deal is that HLSS is taking a bigger piece for less up front than Newcastle did. HLSS is getting 32.5 bps in servicing fees and, based on the Dec 31st estimate of fair value, they will only pay 41 bps up front. In the first Newcastle deal, which was all agency, Newcastle paid 60bps and is getting 29 bps in servicing fees. In the second Newcastle deal, which was only 25% agency and 75% private label, Newcastle paid 42 bps. Its not clear to me whether Newcastle is going to have to manage the cash on the private label, but given the cheap price I wouldn’t be surprised.

I am looking for more ideas in the mortgage servicing sector. Please comment or write me (liverless@hotmail.ca) if you have any ideas.

 

In my opinion mortgage servicing rights (MSR’s) are the best opportunity in the market right now.  The potential is there to return as much as 30-40% IRR for the companies involved. The companies involved are not trading at premiums that reflect this, and in some cases they are trading at discounts to the market (PHH) or with extremely attractive dividends (Newcastle).

Community Bankers Trust: As good as it gets?

Ever since Community Bankers Trust (BTC) announced that they were repaying the dividend on their TARP preferred , the stock has gone into the stratosphere.  Its now become a double since my initial purchase.

What I want to do in this post is look at whether this move to the upside is all I should really expect, or whether this is the beginning of a larger, longer term move.  The question is: Do I have a two-bagger here, or a potential five bagger.

A little history on the company

I bought Community Bankers Trust (BTC) as a turnaround story.  They are a bank that has been trying to reincarnate itself after the first incarnation came close to an early death. My observation is that they have been successfully navigating this resurrection, and with the recent turn in profitability (and a helpful turn in the economy) the bank is on its way to realizing its earnings potential.

How did they get to here?

The original growth strategy was, as far as I can tell, to buy other banks and get bigger.  Witness, the name of the original company was called Community Bankers Acquisition Corporation  (CBAC).  They weren’t exactly being subtle.  Along with the acquisition strategy, the bank seemed to have a “worry about the profitability later” strategy.  This may have worked ok if the economy continued to grow as it had in the early part of the decade but it fell flat along with the economy in 2008.

As best as I can discern the acquisition effort was spearheaded by Gary Simanson. He headed up the original company CBAC, and then moved into a position of Strategic Vice President, a position I don’t think I’ve ever heard of with any other company. According to this article, Simanson was responsible for subsequent acquisitions.

In truth, the timing was what killed the acquisition strategy.  To quickly step through the timeline, in May 2008 the company began its journey by acquiring two local Virginia banks, TransCommunity Financial Corporation, , and BOE Financial Services of Virginia, Inc.  In November the bank moved ahead and acquired The Community Bank, which was a little bank in Georgia.  Finally in January 2009 they acquired Suburban Federal Savings Bank, Crofton, Maryland.

So you had 4 bank acquisitions in less than a year happening at the time of a 100 year financial tsunami.  How do you think things turned out?

Change in Direction

By 2010 Simanson had left the company and the direction of the company was changed to the more pragmatic “we need to get profitable before we go belly up” strategy.

This was described pretty bluntly in the 2010 second quarter report. CEO Gary Longest said at the time:

Our strategy has shifted from that of an aggressive acquisition platform, to one that meets the banking needs of the communities we serve, while providing sustainable returns to our stockholders. To this end, we are taking the necessary steps to return immediately to profitability. We are actively analyzing our market base to assess the contributions of all branches to our franchise value and will take the appropriate actions in the third quarter of this year. Additionally, we will make aggressive expense reductions, and will look to restructure and strengthen the balance sheet. We are confident that the analysis of these potential critical paths and the resulting execution of these initiatives will lead us back to profitability quickly.” “Our goal is an immediate return to consistent quarterly profits. To accomplish this, we have no alternative as a Company but to make clear and intelligent decisions in the next 60 days, no matter how difficult, to accomplish that goal as soon as possible. That is our full focus.”

In a somewhat odd twist to which I’m sure there is a good story, Longest himself was gone only a couple months later. Nevertheless the interim CEO and soon to be permanent CEO Rex L. Smith took up the reins and has carried out the strategy quite well given the circumstances.

Why the TARP payment matters?

As the chart I posted at the start showed, the stock had been trending up for a couple of months but it was really the news of the TARP payment that has sent the shares to another level.

The amounts involved in the TARP dividend are fairly inconsequential.  The accumulated payment is around $1.5 million.  The deferred payments on the trust preferred capital notes looks to be significantly less.

What is consequential is that the regulators are putting their stamp of approval on the bank and giving it a clean bill of health.  What is also consequential is that with the TARP funds being paid the company is setting itself back up towards the eventual issuance of a common dividend.

Where are they now?

Community Bankers Trust has done a lot to lower costs since the clean-up in Q2 2010.  First, they have brought down the interest costs of their deposit base.  Time deposits, which are expensive high interest bearing deposits, have decreased from 73% to 67% of total deposits since the end of 2009.  As well, the cost of the time deposits has come down from 2.9% in 2009 to 1.6% in the third quarter.

The effect has been a step change in net interest margin (NIM) since the strategic direction change in 2010 (note that this graph is a simplified version of NIM calculated as a percentage of all assets rather than the more common formulation of interest bearing assets).

The company also undertook efforts to reduce operating expenses.  The Effiency ratio, which is simply the ratio of the total non-interest expenses at the bank (so the salaries, building costs, lawyer fees, pretty much everything except the actual cost of borrowing money) to the  net interest margin (so the amount of interest made minus the amount of interest paid), has fallen to a low level.

Two ways of valuing the company

First lets look at earnings.  The chart below shows proforma quarterly earnings for the last couple of years.  The proforma number strips out the provision for loan losses, the FDIC intangibles, losses on real estate and gains of the sale of securities.  So basically I looked at the banking skeleton that is BTC.

The bank has consistently been pulling in more than 10 cents per share for the last 3 quarters.  While the numbers ignore the rather large loan losses that the company has had to take, they make the point that once the bad loan book is worked through, the bank has significant potential for earnings.

Now lets look at book value.  I’m going to take this straight from the company’s fourth quarter report.  The bank sports a tangible book value that is much greater than the current share price even after it has double from $1 to $2:

How about the legacy loans?

The remaining negative for the bank is that it still has an extremely elevated portfolio of non-performing loans.  However there are signs that this is abating; the fourth quarter showed more progress in bringing down nonperforming assets.   The bet with Community Bankers Trust remains what it was: the US economy is turning the corner, the Fed is not going to allow it to fall into another recession, and so the worst of the loan defaults are behind us.

To put these numbers in perspective, typically you wouldn’t want a bank to have non-performing loans in excess of a couple of percent.  Many of the best banks I’ve looked at have nonperforming loans of well less than 1%.  BTC, onthe other hand…

So can it go higher?

The question I set out to answer is whether I think the bank can continue to move higher.  A double is great, especially when it happens this quickly, but keep in mind before the summer of 2008 this used to be a $7 stock.  Based on what I have laid out above, I think you can make a strong case that it could go higher.  Things have to go right to be sure, but if they do the earnings and the assets are there.

Bottom line: I’m not selling.

Week 37: Reshuffling the desk

Portfolio Performance

Portfolio Composition

Weekly Trades

A barrel o’ trades

I had some busy lunch hours this week.  Lots of buying and lots of selling.

The theme of most of my trades for the last number of weeks has been to move out of commodity stocks and move into financial stocks.  This week I added, or added to, position in the following financial stocks.

  • PHH Corporation
  • Nationstar Mortgage Holdings
  • Shore Bancshares
  • Bank of Commerce Holdings
  • Gramercy Capital Corp.

So as not to get too far on margin I reduced a number of my gold stock and oil stock holdings commensurately.  I am out of Second Wave entirely.  Likewise, after the takeover bid from Crescent Point I sold my entire position in Reliable Energy.  I reduced my position in three gold stocks: Esperenza Resources, Golden Minerals, and Lydian International.  With the economy continuing to move forward, and especially with the move in the bank stocks this week, I just think there are better places to put capital than gold stocks right now.  However, that remains with exceptions: Atna Resources for instance, which I expect to appreciate significantly from here.

I plan to continue this trend in the coming week.  I may lighten up on Coastal Energy, and if Equal Energy ever releases news about a Mississippian JV on that strength I would scale back that position some as well.  I plan to take a hard look this week at Home Loan Sercive Solutions, which is a mortgage servicing spinoff of Ocwen, and Fortress Invesment Group, which is a private equity firm that manages a number of investment funds but which holds particular interest to me because of the large mortgage servicing portfolio they have been amassing.

So Long Reliable Energy

If there has been one thing the company has been reliable about, it has been underperforming its assets.   In its final denouement, it did not disappoint.

Reliable Energy (REL.to) was taken over by Crescent Point on Wednesday.  I was disappointed by the price they received (~36cents) as it was only about a 15% premium to where the stock traded at prior to the offer.  There was also no mention of REL’s current production in the press release, so its impossible to gauge whether the company is selling on the cheap because of an unsuccessful winter drilling campaign, or because they just wanted to give Crescent Point a gift.  At any rate, I sold my shares at 35 cents and am on to bigger and better things.

The one number that was provided in the release was the updated proved and probably reserves number.

Reliable Energy has proved plus probable reserves of 4.1 million barrels of oil equivalent as of Dec. 31, 2011, and the oil explorer has identified 36 net locations for drilling.

Based on those reserves, Reliable was bought up for $22 per bbl.  Based on the most recent production number of 1,000boe/d, the transaction took place at $95,000 per flowing boe.  All boe numbers are 95% light oil.

It could be worse, but I also think they could have done better.  They have an extensive land position, and there were some rumors that Crescent Point had hit a boomer well on offsetting land.

Nevertheless what’s done is done.  Take your money and move on.

 

Community Bankers Trust pays back TARP Preferred

On Friday Community Bankers Trust announced that they would pay back the dividend that they owed on the preferred shares they issued in relation to getting into the TARP program a few years ago.  They had been deliquent of the past 6 payments on the preferred.  The stock shot up a rather surprising 23% on Friday after the news.  The company said:

“We are pleased to have the ability to begin making our TARP payments again, and to bring all interest payments on our trust preferred securities current at the same time. It shows the excellent progress that the Company continues to make, as well as the close relationship that we have with our regulators to actively address every supervisory issue regarding our safety and soundness. We believe that this is the first step towards more substantive relief under our written agreement and definitely the path to fulfill our TARP obligations. We will continue our efforts towards reducing non-performing loans and increasing profitability to ensure success. At this point, our trends certainly point in the right direction.”

I have to admit I was a little surprised by the move in the stock.  I’m not sure I understand the significance of the announcement.  I mean, it was inevitable right?  The company was stabilizing the business and was getting past the worst of the nonperforming book.  I really thought that the market had seen this coming and had it already priced in.  Apparently not.