Bank investors have outperformed the broader markets by over 10% so far this year, and those of us hidden in the corners owning small, well-run banks may be doing a bit better. (banks in yellow vs S&P 500 in red below)
With that said, we need to bring our brothers, the “deep value” friends rooting among banks trading below liquidation value, into the fold. They have the opportunity to drive their performance a bit further. Like open societies sanctioning dictators, use your power for good to help encourage a few best practices, and to avoid the long list of bank stocks that appropriately have barely moved in years. The time has come for the creation of a Bank Investors Best Practices Union.
In this vein, we make three simple suggestions:
- Join our union. There are no organizer fees, but there are two rules – a) Understand how some managements are misallocating resources and 2) invest on sustainable earnings. These are related. Investing off earnings, as in GAAP income and not adjusted EBITDA like at the digital banks, creates a bias toward managements with a shareholder orientation and away from asset piles trading at 90% of tangible that really should be at 60%.
- Do the work to understand the forward earnings stream. This can be hard. That is part of why entities like Colarion exist, but even a simple process represents progress over lazy price / book investing.
- Send a message to misallocators. Leave someone else to ponder these banks’ lineup of poison pills, branch expansion strategies, combined CEO / Chairman roles, jets, 80% efficiency ratios, 20% options packages, and cash acquisitions with shares trading 90% of tangible book value. If we can create just one uncomfortable shareholder meeting, just one man in the back asking: “Can you help us understand how our stock has not moved in 10 years, and why we trade at below liquidation value?” then this post has helped its readers. Put another way, buying stocks of the lowest performers with hope as a strategy is akin to extending the contract of a football coach that just finished 1-10.
What specifically are we organizing around?
First, we are recommending an investing style rather than specific names, because our registration requires we know you the reader better before we are allowed to suggest specifics. Second, just because a management does not adopt a best practice does not mean there is malicious intent. The issues below are common. Still, we believe they may affect share performance over time.
Some issues in detail:
Lopsided compensation: Hilltop (HTH) is a $19bn, mortgage-oriented Texas Bank. Director fees are $48,000, except one director makes almost $1 million every year, good or bad. This director plays an important role in strategy, but every director should add value in some way, and we wonder if almost $1 million is the right number. In part due to mortgage and in part due to compensation, HTH has a 75% efficiency ratio, one of the higher inefficiencies among banks over $10 billion. Other unusual situations are Republic First (FRBK) and until recently Bancorp (TBBK). Richmond Mutual (RMBI), directors make around $350,000, and Eastern Bancshares (EBC) management also has an interesting arrangement.
Misunderstanding of when to repurchase: If a bank trades below tangible book and management is not repurchasing at least some stock, unless in a legal or regulatory restriction this is usually a red flag. Bank of Utica (BKUT) comes to mind at 53% of tangible and no shares repurchased for years.
Large boards: Hilltop and Uwharrie (UWHR), each have 20 members per S&P. Large boards are expensive and may act as a brake on strategic progress unless one person directs all the decisions. In that case, are 20 members necessary?
Not for sale, but not transparent: Circumstances can change, but North Dallas (NODB) Northway (NWAY) and Peoples (PFBX) are banks that may not be for sale at any price, per management preference. The Bank Investors Best Practices Union would recommend banks adopt reduced voting share classes, such as at First Citizens of NC or Alpine of Colorado, so investors can know what they are buying and remove the terminal value from their discounted cash flow calculation.
Toying with minority owners: Solera (SLRK) has a director who owns over 50% of the bank. His (one-branch) bank purchased a jet, a family member without apparent industry experience is on the board, and he proposed himself a $500,000 director salary in the proxy. Who’s going to vote against him, and who cares if you do?
Palaces: First United Security (FUSB) recently built a headquarters slightly smaller than the one occupied by Servisfirst (SFBS) two miles down the road. Servisfirst is 15x larger by assets. I understand FUSB is working to lease some of the building’s space out. Our union supports banks that invest in loans and business development ahead of real estate.
Branch Strategy: Republic First (FRBK) has 35 branches, 8 with deposits less than $75 million, and a 50% loan / deposit ratio, suggesting if anything they need fewer deposits and branches. Branches were a reasonable idea before remote deposit and docusign, but today with cloud core processors emerging, the trend of branch closures may accelerate as no area really needs more than a few in the event of an emergency or check too large to deposit remotely.
Goodwill: Peoples (PEBO) just paid 4x book for a equipment lease company. Regions paid 3x book for a home improvement lender because that lender was set up on several builder websites (“embedded”). Block paid $29 billion for a BNPL lender. All these transactions are not accretive for many years. Home (HOMB) CEO Allison believes deals should be immediately accretive. Unless the strategy rationale is revolutionary, our Union favors Mr. Allison’s point of view.
Mutual Holding Companies (MHCs): In theory these allow thrift conversions to manage their capital more efficiently. In practice, shareholders do not have a vote because they own a minority of the equity.
What’s in it for union members?
- Performance Following “best practices” is a non fungible concept, so we can’t prove that it outperforms, but experience of companies like Solera (SLRK) below are relevant
2.Leverage your allocation. Every day that goes by, passive grabs a greater share of the equity market, shown below courtesy of S&P. Passive investment funds almost universally support management in shareholder votes. A bigger active allocation to best practices creates a bigger passive allocation as passive follows active.
Leave behind Bank of Utica, Peoples of Biloxi and the others. Free up your capital and your frustration…
About us: Colarion is a diverse investment advisor, with expertise in the financial services sector. The firm manages both separate accounts and a pooled sector fund. For additional detail you may contact us below or see: http://www.colarionpartners.com. Thank you
Disclaimer: The writings in this note do not advise readers on investment transactions. Only clients who have executed an account management agreement with Colarion LLC are under advisement from Colarion, so that their particular tolerances and objectives may be considered. Readers should assume Colarion may be long or short any and all tickers mentioned in this publication, and that investing in securities includes inherent risks which may lead to the loss of capital.