Banks, Corporate Governance

A Tool for Outperformance: Finding Great Businesses Hidden Inside “Boring” Banks

Improve portfolio growth by avoiding the “clones” Owning typical banks can be a losers game. Most banks compete on price, fight low rates, and miss out on innovations like digital currencies. For these reasons among others, regional banks have lagged the broader markets over the past 5 years.

But among the 800 publicly traded banks, several innovators consistently outperform. While it’s hard for large banks to distinguish themselves, it’s much easier at $5 billion.

The innovation champion

Silvergate Capital (SI)

Silvergate (above) decided a few years ago to lever its bank charter to start a network facilitating exchanges of dollars to crypto. Others have followed but Silvergate took the lead.

Colarion’s modest position early in Silvergate has become significant. Priced like a bank, until it wasn’t, Silvergate has appreciated as much in 1 month as the entire sector has in five years and is the story in small banking in recent years.

While the market realized Silvergate all at once, sometimes it takes a few years to recognize innovation.

Community First (CFST) is a small California bank that built out a payments business. It has trounced the market despite still trading at approximately 25% the multiple of the S&P 500. Live Oak Bank’s (LOB) chart is similar, despite a heavy expense load, because the market recognizes the upside optionality of its innovation.

There’s a simple way to find these banks.

  1. Look for fee income at least 20% of revenues.
  2. Remove the banks getting fees primarily from mortgage.

It also helps to have a view on which fee businesses have sustainable margins and growth trajectory, and which banks are reasonably priced. MCB, TRUX, TBBK, UNIB, ESQ are a few among many that have developed valuable non-commodity fee businesses in recent years.

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