Posts tagged ‘regional banks’

Jan 6

SB Financial: Like watching paint dry

This is the first of some short write-ups on the community bank stocks that I have invested in over the last month. I mentioned in my portfolio update that I had thought the community banks taken a basket approach, buying 5 names (some of which I had already owned a small amount of in some accounts for a long time). I’m not sure if I’ll write-up all of them, but I’ll try to do a couple.

My thoughts behind the trade are that pretty much all the community banks are going to benefit from a few tailwinds over the next year. These are:

Higher interest rates leading to higher net interest margin
Lower taxes (most community banks pay over 30% in tax)
Reduced regulations (reduced compliance costs)
Better economic growth and a better environment for loans

I want to preface this write-up, by saying I don’t really know if any of the banks I have invested in are the best way to play a rise in community/regional bank stocks. There are so many bank stocks out there. I can’t possibly go through them all. I have a list of about 40 that I looked at and I picked 5. 20 were small and 20 were larger names that I was looking at for baseline. The stocks I bought were those that compared the most favorably. They also seem reasonably priced to me. But there may be (likely are) better ones out there that I just haven’t heard of.

I’m starting with SB Financial (SBFG), which is the new name of a long time holding of mine Rurban Financial. I actually wrote about the stock first here, almost 5 years ago! Its probably the name I like the best out of all the stocks I bought.

SB Financial operates primarily in Ohio with 18 branches, though it does have a branch and loan office in Indiana and another loan office in Michigan.

Overall loan growth in the last few quarters has been in the mid-teens year over year:

In a 2015 presentation they describe their growth markets as Defiance, Columbus and Toledo:

I haven’t found any newer data describing loan growth by market.

SB Financial is not as heavily into residential loans as some banks. Only about 22% of loans are residential. Most of their loans are either commercial, commercial real estate or construction loans. I know that construction loans are typically riskier, and the company does not break-out construction loans from commercial real estate from what I can see, so this might be seen by some as a flag.

Nonperforming assets are only 0.6% of total assets. So at least their history is one of prudent lending.

SB Financial generates a fair bit of non-interest income. Apart from the usual fee income, they have a mortgage origination segment that has been growing originations over the last year (up from $86 million to $117 million year over year in the third quarter). While rising rates will have an impact on this business, on the third quarter call the company said that 88% of originations were new money, so refi’s are only a small part of the business. The company also holds a position in mortgage servicing rights that will perform well as rates rise, offsetting the impact of reduced refinancing.

Other non-interest income is generated by the asset management business. Assets under management (AUM) grew to $376 million in the third quarter, which is up 11% year over year. Fee income was $700,000 for the quarter, so their fees are around 0.7-0.8% of AUM annualized.

To fund their loan growth the company growing its deposits by adding branches. At the beginning of 2016 they expanded full service banking into Columbus. On the second quarter conference call, they have pointed to a strong start for deposit growth in Columbus, up $5.8 million in first 6 months, 43% since the beginning of the year. The company is planning a similar full service entrance into Bowling Green in the fourth quarter of 2016.

In the past few quarters deposits have been growing at a similar rate to loans, 15% year over year.

SB Financial trades at 146% of tangible book value. They have some goodwill on the balance sheet, which makes their price to book a little lower, 130%. The P/TB is the highest of any of the banks I bought. However they have been the best of the bunch at allocating capital. Return on assets in the third quarter of 2016 was 1.28% and was 1.1% for the first 9 months of the year. Return on equity was 11.9% and 10.3% respectively. I have read that if ROA is above 1% and ROE is above 10%, the bank is doing a pretty good job.

The addition of new branches has likely been a drag to earnings. The company’s efficiency ratio (this is the ratio of their operating expenses to revenue) was 68% in the first 9 months, which is average at best. However as they build the branches I would expect this to come down.

The company reported $1.01 EPS in the first 9 months and 40c in the third quarter. They trade at a little under 12x earnings on an annualized basis of the 9 month numbers. That doesn’t seem unreasonable to me given the 15%ish growth that they are producing.

I’ve owned this stock for 5 years and its given me no surprises. I don’t expect one going forward. Its like watching paint dry, and that’s OK.

I expect the company to keep on generating returns on assets similar to the past, continue to build out its deposit base into new markets (first Columbus, then Bowling Green) and grow fee income through asset management and mortgage originations. Simple story. Hopefully with an additional boost from a federal government policy revamp the stock can trade up to 2x tangible book.

Oct 18

Falling NIMs, Rising Mortgage Banking and two new bank stocks: Monarch Financial and PVF Capital Corp

One consequence of the quantitative easing campaign that was initiated by the Federal Reserve is that is caused a rise in mortgage backed securities, and a corresponding drop in interest rates for those securities. To illustrate, below is the 30 year Fannie Mae.

This drop in rates is bad for holders of MBS debt who depend on the yield that it returns. As a consequence many mREITs have been under pressure.

To varying degrees banks are in same boat. You saw this with the release of results on Friday from JP Morgan and Wells Fargo. The subject was discussed here in the Financial Times.

But I think you have to be careful before painting all banks with a broad brush. The extent of the damage depends on the percentage of assets that each bank has in securities in general and in mortgage backed securities in particular. This can vary quite a bit, especially among the smaller community banks.

I have looked at each of the banks I own. Most are not overly exposed to mortgage backed securities or to securities in general. The table below shows the total investment security exposure vs. loan exposure for each bank, and then breaks down the investment securities by type. Read more

Sep 1

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The Community Banks of Arbitar Partners

You just keep on trying to find things that you think are cheap and that you think will wind up being worth a fair amount more then they are worth now.

– Paul Isaac is the founder of Arbiter Partners

Paul Isaac is the principal and portfolio manager of the hedge fund Arbitar Partner. Arbitar has had 20% plus returns per year over the past 25 years. They are one of a small group of funds actively proving that the efficient market hypothesis is hooey.

Every quarter hedge funds have to report their holdings to the SEC. When I caught wind that Arbiter had invested in a number of community banks over the past two quarters (thanks to an article by Tim Melvin), I felt that I better take a look at their 13-F filing.

What I found was that Arbiter had, as of June 30th, positions in the following community bank stocks (name and symbol followed by share amounts held by Arbitar Partners in brackets).

ASB BANCORP, ASBB (30,433)
AMERIANA BANCORP, ASBI (14,469)
HOPFED BANCORP, HFBC (29,334)
INTERVEST BANCSHARES, IBCA (16,317)
LAKE SHORE BANCORP, LSBK (53,171)
LAPORTE BANCORP, LPSB (10,877)
OCONEE FED FINANCIAL CORP, OFED (19,335)
PREMIER FINANCIAL BANCORP, PFBI (11,748)
PEOPLES BANCORP OF NORTH CAROLINA, PEBK (22,355)

I’ve looked at each of these stocks, with the exception of Intervest Bancorp, in some detail. I didn’t look at Intervest because I missed them on my first scan of the 13-F and didn’t realize they should be on the list until I had already finished writing this up.

The Objectives of the Exercise

I’m trying to get two things out of this.

First, I’m looking for potential investments. I’ve been adding to my community bank investments over the past two weeks. I added PremierWest Bancorp and Sound Financial, and I would like to add others if they present a clear story of a combination value, growth and turnaround.

Second, I hope to gain some insight into the criteria that Arbiter is using when they choose bank stock investments. So I’m looking for patterns.

I’ve left the list in point form because I don’t really want to spend the time to format it into some sort of spreadsheet. And anyways, some of the observations are qualitative and so are best left in point form. Finally, I think better when I read through a list than I do when I see a bunch of numbers in columns and rows.

View this document on Scribd

What is Isaac Thinking?

The first thing that I noticed was that the size of each bank is between $50 million to $100 million. Isaac is clearly going after the overlooked, illiquid, unfollowed community banks. I wonder whether his positions have been taken from some sort of stock screen that weeded out banks outside of this range? It seems coincidental that all of the bank stocks Isaac likes just happen to have this narrow range of market capitalizations.

To help get some additional insight into the strategies that Isaac might employ, I scoured the web for interviews and quotes. Among other things I found this short clip from a CNBC interview.

In the interview Isaac describes how if you have a good manager of the business, the balance sheet should lead the income statement. He goes on to explain that Wall Street focuses on the income statement, and doesn’t always understand its relationship to the balance sheet. What he tries to do is to buy cheap balance sheets with good managers, and then wait for the balance sheet to begin to impact net income.

This is a common theme on the list. With the exception of Oconee Federal Financial, every one of the banks on the list trades at a discount to book value. Some trade at a significant discount. For example, HopFed Bancorp ended Friday at $7.73 while its tangible book value is $13. Ameriana Bancorp closed at $6.54 with a book value of $10.80.

While earnings at many of the banks aren’t stellar, what Isaac appears to be betting on is improved earnings over time as the balance sheets get deployed to more profitable assets. In fact, it seems that Isaac has gone out of his way to pick banks that have had, up until now, poor return on assets and equity. The only bank with return on assets higher than 1.0% was Oconee Federal Financial. Next on the list was Lake Shore Bancorp and they were still a less than stellar 0.77%. The others all had ROA of 0.5% or less.

One of the reasons that bank earnings have been lackluster is because many of the banks have been making significant provisions to their loan books. Ameriana took provisions for loan losses of $624,000 in the first half, versus net income of only $798,000. ASB Bancorp had negligible net income in the first half of the year but took loan loss provisions of $0.34 per share in the first half and $0.23 in the second quarter. Premier Financial had a little over 50 cents in earnings but took loan loss provisions of $0.21 per share.

Once these loan loss provisions taper off, you can expect that earnings at these banks will look a great deal stronger.

The strategy makes sense and mimics my own. I tend to focus on more distressed banks than Isaac (though he does have one what I would call distressed issue in the list; Premier Financial, and another semi-distressed one, ASB Bancorp), but we both appear to be looking for banks that don’t have very good earnings right now, and so are being penalized by the market, but have very good earnings potential if they could get past the issues that have been dragging their earnings down. its a strategy that seems to work.

Another commonality among many (not all) of the banks is that they have unrealized gains on their securities portfolios. In some cases, these are substantial. HopFed Bancorp has over $2 per share in unrealized gains. Peoples Bancorp of North Carolina has over $1.50 in gains.

Finally, there seems to be a pattern with respect to location. Three of the banks operate out of North Carolina with another in South Carolina,while two banks operate in each of Kentucky, New York and Indiana. In addition to Kentucky, Premier Financial has branches in Ohio and Virgina.

There is a cluster here around the middle eastern states. I would note that if you look at the Economy.com recession risk indicator, the majority of counties in these states are in “Recovery” mode. It could also be that Arbiter Partners operates in New York and so they looked for banks that allowed for due diligence within a reasonable traveling distance.

And what’s different

While there are similarities, almost as interesting is what is not similar about the list. First of all, the banks run the whole gambit of loan quality, from Oconee Financial, which has non-performing assets at less than 1% of assets, to Premier Financial, where over 6% of loans are non-performing. Three of the banks have TARP preferred securities on the books (Premier Financial, HopFed Bancorp an Peoples Bancorp of North Carolina), though admittedly in each case the bank appears to be well on their way to paying off the funding, which would likely be a significant positive event for the company. There are banks trading at fair earnings multiples (Oconee Federal and Lake Shore Bancorp, Ameriana Bancorp) low earnings multiples (HopFed Bancorp,Peoples Bancorp of North Carolina, Premier Financial) and banks with no or negative earnings (ASB Bancorp).

Clearly, if the bank has underutilized assets and is trading cheaply on the basis of those assets, Paul Isaac is less concerned with the reason why this may be the case than that it is the case and that an opportunity presents itself.

Any Prospects?

Honestly, they are all prospects. Each of these banks looks like a solid candidate for future price appreciation. Paul Isaac didn’t get 20% returns for 25 years by picking duds. I could probably stick each of these banks in a portfolio, tuck it away for a year, and I bet that absent a collapse in Europe or a return to recession in the US I would be up 15-20%.

The two banks that I see the most potential for are two of the most distressed issues; Premier Financial and Peoples Bancorp of North Carolina. Both stocks are trading well below tangible book value (the discount is 24% for Premier Financial and 39% for Peoples Bancorp. Both banks are already earning good money (annualized $1.08 per share for Premier Financial and $0.90 for Peoples Bancorp), and both banks have catalysts, in addition to basic balance sheet earnings leverage, that should allow them to increase earnings.

Peoples Bancorp took over $0.45 per share in loan loss provisions in the first half of 2012. As I mentioned earlier, they have over $8 million in unrealized gains on securities in their portfolio. And their loan book has shown consistent improvement; loans past due have dropped from $38 million at year end to $26 million at the end of the second quarter and 30-89 delinquents have dropped from $28 million to $16 million in that same period.

Premier Financial took $0.21 per share in loan loss provisions, have over $1 per share in unrealized gains on securities and are also have improved their delinquent loans over the last 6 months.

Both companies are also in the process of paying down their TARP preferred shares. I suspect that once TARP is paid off, and the banks are free and clear of any government support, the market will be more inclined to revalue the stocks toward book value.

Jul 31

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Three Community Banks worth keeping an eye on Part II: Shore Bancshares

I owned Shore Bancshares earlier this year but don’t own it now. It was one of four banks that I bought back in January when I jumped into the community bank sector whole heartedly. While the other 3 banks I bought worked out to various degrees, Shore did not, and I sold out shortly after the first quarter results came out for a small loss.

At the moment I’m out, but Shore is not forgotten. I continue to review the company’s results and look for an improvement that would justify an entry point. Looking at the second quarter, while the eventual value proposition is still there, the company doesn’t seem to have quite turned the corner just yet.

Shore operates 10 branches in Maryland and 3 branches in Delaware. The majority of its lending activities revolve around the commercial and residential real estate market in these regions. Shore has a particularly high percentage of commercial real estate loans. Of the company’s $819 million in loans at the end of the first quarter, $315 million were commercial real estate, while $309 million were residential real estate and another $114 million were construction loans.

The loan book has been hit by the downturn in the economy in Maryland. Maryland’s economy is not doing badly, but it is also not doing particularly well. The economy has pretty much mirrored the US as a whole. Below is an Economy.com table of the key economic regions in Maryland. The table denotes each area as either being in recession, being at risk, being in recovery, or expanding.

Another informative research piece on Maryland’s economy was put out by JP Morgan. One point made that I found of particular note (and that is illustrated in the chart below) is that Maryland (not surprisingly) derives a larger than average percentage of economic activity from government.

This would have to be considered a headwind to growth going forward. As one Baltimore economist put it:

We know the decline in federal government outlays has just begun,” said Anirban Basu, a Baltimore economist. “The economic outlook, I think, is pretty grim.”

The article goes on to point out that “because Maryland gets a disproportionate share of federal contracting dollars and other spending, it’s likely to feel a harder hit from any reductions [in government spending]”

To drill down a bit further to the counties Shore operates, (Talbot, Dorchester, Kent, Caroline, and Queen Anne’s), you can see from the following unemployment charts that each fairly closely mimics the experience of the US, with some improvement from the worst levels of 2009-2010, but still an elevated unemployment level.

Talbot

Dorchester

Kent

Caroline

Queen Anne’s

The economic malaise shows up in the impaired loan book. Shore has $33 million in impaired construction loans (28.9% of outstanding), $30.9 million in residential real estate loans (9.9% of outstanding) and $30.6 million in impaired commercial real estate loans (9.7% of outstanding).

The problem with Shore remains what it has been for the last few years. How much longer will economy lead to deterioration of the loan book deteriorate?

Company CEO W. Moorhead Vermilye did not paint a terribly encouraging picture in his second quarter comments:

“The operating environment remains tough as we are not yet seeing a meaningful upturn in the real estate related activities that drive the Delmarva economy. We continued to work diligently to resolve and dispose of problem loans, as reflected in a higher level of troubled debt restructurings this quarter,”

So those are the negatives, and why I am not ready to buy Shore just yet. The positives with Shore is its valuation is compelling in the event of a recovery.

The potential when Shore recovers

A great deal of the current problems are priced in the stock. Shore has a tangible book value of over $12 per share. Its trading at less than half of book. The underlying earnings potential of the franchise remains strong; if you ignore the effect of all the onetime charges due to bad loans, the underlying banking business (ex provisions, one time charges, and gains) has been producing earnings at over a $1 per share clip for the last few quarters.

But even this may underestimate the earnings power of a stabilized Shore. Again excluding the onetime charges, ROA and ROE are solidly below where they were before the financial collapse. This suggests to me that once (or I guess if) the bank has its problem loans under control, they can embark on a cost reduction strategy to size the bank to the new level of business.

You can see the same influence if you look at the efficiency ratio, which has been hovering around 100% for the last six quarters.

Not quite there yet

One positive for the second quarter was that Shore did see a significant reduction in charge-offs. Charges were cut to half of what they were in Q1, extending the previous downtrend that had been in place before Q1.

I would be more excited about this reduction in charge-offs if nonperforming assets had shown an improvement. Unfortunately they did not.

Until I begin to see a leveling off and ideally a drop in the non-performing assets, its difficult to make a move into the stock.

Other risks

Apart from the economic risks I already outlined and the presumed impact on the loan book, there really isn’t a lot else to worry about with the business. Reading through the risk factors of the recent 10-K was mostly an exercise in the plagiarisms of the standard banking risk fare:

Concentrated Commercial real estate loans are being affected by the economic downturn
Interest Rates falling
The market value of their investment portfolio declining
Competition
Funding Sources
Key Personnel

The only item of any concern is the one I’ve already highlighted. Their loan portfolio, and in particular their commercial real estate portfolio, needs a strong economy to right itself. Its really just a wait and watch until the bad loan book stabilizes.

Waiting on my hands

The reason I am reluctant to buy Shore is because until they start to see a sustained downward trend on their nonperforming loans, the company remains at risk for panic. We saw that panic back last fall when the stock fell into the mid-$4s. It could happen again with the right confluence of European and US financial worries. Rightly or wrongly, the stock will likely remain range bound until the book turns around, and we won’t begin to see that until at best October, when the next quarterly is released. I, before then, the stock dropped another 15%, which would put it in the $4.50 range, I would be tempted to buy. Absent that, I will wait patiently on my hands.