It’s better to give than to receive stock in a bank that puts shareholders second.

A rundown of banks that have earned holiday greetings

2020 has been a tricky year for bank managements. Managers are supposed to look out for owners, customers and employees, and while the best ones strike a balance, most can’t quite get there, and it’s the markets job to call them out of that. Today’s message helps us determine who gets the gift of cheap capital.

First, a reminder – we invest to get a return, but investors also make capital expensive for bad managements & businesses but cheap for those that are good. For example it took 5+ years since the first oil crash, but eventually the investment community has driven frackers out of business. In Europe, policymakers have ruined the banking sector and taxpayers in Spain and Italy may soon be forced to buy equity to keep this critical sector alive. This process of shunning bad concepts is great for prosperity long-term and differentiates us from China, Cuba etc.

In this vein, let’s look at a few bank management teams who respect investor capital and deserve thanks this holiday season, vs. a few burning the turkey.

Giving thanks for some banks that gift shareholders this holiday season:

Wayne Savings (WAYN): In recent years Wayne withstood not one but two proxy fights with Stilwell Value, known as a tough but fair bank activist firm. After the second, management proposed a deal – make peace by ramping ROE higher. Stilwell has relented and subsequently received a cornucopia of shareholder goodness:

For those new to bank language, ROTCE is return on tangible equity excluding preferred, and efficiency ratio is like the opposite of the operating margin. In other words, the lower the efficiency, the less fat on the bone. Some banks run efficiency as low as 30%. Below-average performers consistently run over 60%

Wayne CEO VanSickle, who joined in 2017, has created a sustainable high performing bank – controlling expenses, repurchasing shares, and growing loans. His competence has allowed the bank to maintain its independence, beaten his index by 40% since arrival, and saved numerous jobs. Spiked egg nog party – Everybody Wins.

Pacific Financial (PFLC): Common Sense Pudding from CEO Portmann. If you trade 75% of tangible, credit is under control and you are posting 10-15% ROTCEs, consider a share repurchase. It’s likely a better use of capital than supporting that 3.75% fixed shared credit in the latest me-too multi-family project. Her actions will be remembered in 2021.

Centric Financial (CFCX): Same as above. To be clear, there are 50+ other banks in this category but CFCX and PFLC come to mind as banks with a growth plan also competing for capital.

All the share tender banks: HTH, AMTB, MVLF

Special recognition for the public banks running sub 35% efficiency: Servisfirst (SFBS, has outperformed its benchmark by 34% the past year), Merchants (MBIN, outperformed by 70%) Parke (PKBK, underperformed by 8% – it’s in New Jersey), and the popular Hingham (HIFS), which has outperformed the banks by 37% the past year and by 320% the past decade. You can’t reach 35% without a cultural recognition for owners.

Southfirst (SZBI) finally recognized they were too small to scale, so sold for a 100% premium. Merry Christmas!

Banks where we wonder if shareholders are the turkeys:

First, the names below are not necessarily “uninvestable” – in fact one of them may soon be an excellent investment and has rallied 40% in the last 2 months. However, recent performance or actions raises the question, “are employees ahead of shareholders?”

We have to start with the “100% efficiency club”, where more than 100% of revenue leaves via expenses. 14 of 770 public banks claim membership. Most are stuck due to small size but two are not – $670 million Carver (CARV) and $430 million Golden State (GSBX). Digging into the issues at Carver, a “special situation,” is itself a poor risk/reward in this forum and we will leave it that it is part of the 100% efficiency club.

Golden State has issues with its regulators and it’s not clear how quickly they can address them and certainly not clear one should pay 79% of tangible to see where things go.

BOL Bancshares (BOLB), Peoples of Biloxi (PFBX) and Glen Burnie (GLBZ) have an assigned seat on this list if judging by ROE or shareholder return over time. With that said, let’s see what unfolds at Peoples in the weeks ahead.

First United (FUNC): This is well documented by Driver Management, which is suing directors under the premise of rigging their own election. First United has not grown assets in a decade, in part due to restricted access to capital markets.

Republic Bank of Arizona (RBAZ) is using a lawyer to send letters to a major shareholder. Whenever a bank trades under tangible book, as Republic does, the market is judging the bank guilty of being worth less than going concern value until proven innocent. The shareholder-friendly solution is to fix quickly or merge.

Customers (CUBI) claims it is looking at launching a “massive” buyback soon, because it trades at 67% of tangible. I’m listening, however part of the discount may stem from a senior manager taking home ~$20 million in compensation per S&P over the past 5 years despite the bank not breaking 1% ROA.

Investors (ISBC): Another sub 1% ROA bank where the risk officer, as one example, receives $2mm in total annual compensation. The dollar doesn’t seem to go as far in the senior management labor pool as it used to. Investors runs a 53% efficiency over the past year. One wonders if it could have been closer to 40%.

Have a Happy Thanksgiving, and take care of your giving!

The Banks that Understand Crypto

Cryto – the marketing construct that meets a need. Perhaps no theme is as popular among the many macro investor subscription services available than hating fiat money. What’s not to hate? Inflation takes 1-2% away annually according to fuzzy government statistics, or 5-8% if tracking the amount of liquidity growing each year in the system through M2. This seems like more than enough to handle population growth and maybe is instead a way to quietly keep 401K holders content while gradually stealing the value of their savings.

The preferred way to address this seems to be gold for Gen X and older, and crypto for anyone younger.

Also, if we hate money then perhaps we hate companies that are composed of money, which are the banks?

The beauty of banks is that there are smart banks and dumb banks. In its hurry to dislike banks, the macro newsletters are thinking of banks such as Bank of America and Wells Fargo. We can all agree that Wells in its current form is closer to a “dumb bank” and has fallen 50% in 2020 as the market came to grips with this.

Colarion tends to focus its efforts away from these stale ponds and thinks of the sector in the context of Servisfirst, Esquire Financial, Live Oak and others like them.

The folks at MVB Financial in West Virginia are an example of a “smart” bank. CEO Mazza was interviewed for a recent fintech survey and shared that banks are “at risk of becoming taxis in an Uber world” (https://seekingalpha.com/article/4358901-what-gen-z-thinks-banks). He has launched a business to gather deposits and related fees from each Draftkings and Kraken, among other crypto and fintech ventures, and the table below shows the company’s growth in gambling deposits. MVB’s crypto strategy, among other ventures, is an example why the bank is thoughtful about where the world is headed.

Who else is like MVB on crypto?

Silvergate Bank (SI) gets it. They have created an “exchange” for institutional investors to dollar settle crypto transactions, and the market has noticed:

A few others including BankProv (PVBC) and Metropolitan (MCB) are active in crypto as well.

One last company is worth mentioning:

(news.bitcoin.com)

Who knows, we may even see bitcoin on some banks’ balance sheets in the years ahead?

For those of us whose job is to find the smart banks, the understanding and adoption of crypto is one more tool in that kit…

Regional Banks (via KRE) up 24% in a month – more follow-through or fake news?

Many financials have ripped higher in October vs a flat market, off the back of 90% of reporting companies beating estimates; most of them by wide margins. However financials also rallied in June before giving back almost all their gains, and post election waters may be choppy.

Over the coming months, the rally will hold for two reasons – operating leverage and sustainable money flows. In specific, we just saw the beginnings of operating improvements, and can now expect some level of multiple expansion from accompanying money flows.

How rallies hold: We can track how stocks move over time by combining

1) cash flow / earnings growth with

2) multiple expansion / compression on that earnings and finally

3) Share dilution

To use a popular example, below is Apple over the past year. Almost all of the stock’s upside has been from holders willing to accept a lower future return from a higher multiple:

Banks show the opposite story, often generating earnings growth but suffering multiple contraction. Ameris Bancorp (ABCB) is a typical example:

So, where would the cash flow and multiple expansion come from to support recent bank gains?

Part I: The earnings have returned… Most smaller banks are earning what they earned a year ago (below). Some of this is from mortgage, but banks have other levers to pull, including investing current substantial excess cash into mergers, buybacks, and loans to bolster earnings. See arrows below pointing to happier times in 2019, vs recently reported 3Q20 earnings:

However, the market has given the sector no multiple expansion as yet – most small banks have few estimates, so when using dividends and price / tangible book, the median valuation for small banks remains near March fall-out zone levels, back when we were tracking northern Italy hospitalizations.

Part II: Multiple expansion comes from money flows, which are on deck: Money flows will change in coming months and quarters, for a few reasons:

  1. Money will flow in from the sector itself This includes buybacks and mergers. 45 banks reinstated share repurchases in the last quarter or so. Another approximately 100 – including the largest banks – should join them in the coming 3 months. On the merger front, industry consensus is the spring is coiled, with reversion to norm dependent on a credit backdrop. Third quarter results, including zero and negative provisions from some lenders, suggest the spring can now release.

2. Money returning from “hideouts”

Between mid March and Third Quarter earnings, no pension fund, endowment or other large allocator lost his or her job by being underweight financials. Those allocators now have a decision to make given recent results. Continue with Nasdaq 100 at 2-3% earnings yield or get 3x that with banks? Own treasuries paying 80bp or get 3% bank dividends on 30% payout?

How much risk is involved? One bank raised defensive common equity between March and today. Only a handful among 800 public banks even cut dividends. This stability has value over time.

You can buy a “cyclical” like Great Southern Bank (GSBC) at 9x rising estimates, 3.3% yield, repurchasing shares, reporting steady results through 2020, or you can buy the market at 21x and half the yield, getting a share of Apple’s 60% multiple expansion off the back of 12% cash flow growth. Further growth is not guaranteed – picking on AAPL, the company accepts ~$10bn a year from Google to protect a search monopoly while charging app store fees that may not hold up well in a blue wave. Can you name a recent Apple product innovation?

The money will flow to where it’s treated best, and banks have a good argument.

Looking for bank stocks in the dumpster? Not everything can be salvaged…

S&P periodically publishes a popular article highlighting banks ranked by lowest price to tangible book value. Below is a recent sample of the banks on the list:

Value investors like to sort through these banks because in theory they can shoot up in price with more adept management or in the event of sale, as recently occurred at Standard Bank of Pittsburgh or Security Federal of Tennessee:

Standard
Security Federal

There is an issue however – for every one Standard, there are multiple value traps, run by managements indifferent to their ownership base. Banks are particularly susceptible to this because activists are uncommon across much of the country and it can be expensive and draining to run against entrenched managements – much easier to simply sell shares.

As a result we see 20-year charts like this at Glen Burnie (GLBZ) of Maryland:

Peoples Financial of Biloxi (PFBX) is grooming a successor for its CEO. That successor is the CEO’s son.

Even owners of SFBK, had they bought any other time than the last 18 months, would have to explain performance:

How to sort trash from treasure? There are 800 publicly-traded banks so folks following the sector become adept at developing a criteria for un-investables. Some screens might include:

  • Not located in a demographic / fiscal hazard zone area (NJ, IL, CT, among others).
  • Not so small they are trapped either needing to raise capital at deep discounts to book or hoping to sell for book value given the bank is essentially a branch with too much management (about 10 banks on this list)
  • Not a transactional bank (USMT, FIEB, HAFC have transactional elements).
  • Not a corporate governance exception. Customers Bank (CUBI) CEO Sidhu was removed in a shareholder revolt at Sovereign Bank in 2006. If CUBI’s 3x P/E and ~ negative 50% 3 year return are an indication, he has not yet been granted benefit of the doubt 14 years later. The executive pay packages at CUBI are…unusual.

Plenty of CEOs are working overtime in solid and sustainable business models, with heavy fee components, to earn shareholders money. The compounding from these positions can generate well more over time than a merger premium. It would actually be a disappointment of sorts if a bank like Truxton or Communities First (both below) were to sell – chances are good the buyer would replace a predictable, high margin return stream with one that is more volatile and lower margin…

Today’s market allows us to have higher quality bank management teams, often at discounts to book. We should take advantage.

The Perma-Short Banks, a Sequel on the Future

Earlier this week I published a column on five ways US banks outperformed their European and Japanese counterparts. Those included capitalization, efficiency, return of capital, governance and regulation / government interference.

But as we see the EuroStoxx bank index reach an all-time low this week, many in the market persistently suggest US banks are headed in the same direction as the hapless foreigners, so much so that it’s nearly conventional wisdom.

So the US is in better shape now, but is Pal right?

Today’s sequel answers that question by showing why US banks are the way they are, and why they will continue to run circles around Europe and Japan. We know that US banks return capital and Europeans don’t, but why? Why does JP Morgan spend hundreds of millions to lobby while Paribas does what they are told to do? Why do we see bad decisions cascading to the point the EU banks are trapped, trading at 20% of tangible book and with no choice but to merge, shrink, and deflate their host economies?

The answer is greed.

These problems develop when the 9-member Management Board of $1.5trn asset Deutsche Bank owns less stock cumulatively than the Chief Risk Officer of $17bn Independent Bank of Texas owns by himself. I’m confident that risk officer is one of thousands of officers in the US banking system checking their stock price daily.

9 guys who could care less what happens to the stock

Small banks in the US brag about how much insiders own. Management at Deutsche own 0.03% of a stock with a $13 billion market cap. Speaking of $13 billion, that’s the amount of dividends JP Morgan will pay this year, an amount CEO Dimon referred to as a “drop in the bucket”.

Gekko said “greed works” referring to corporate takeovers, but it also seems to work for banking systems.