• 4 strategies to outperform in a niche investment corner are below.

• One of the strategies (buybacks) is likely to hold up well even in a choppy market backdrop.

The liquidity conundrum: A number of clients tell us they have their cups overflowing with liquidity, but they aren’t comfortable with bonds, the stock market at 25x+ “adjusted” earnings, or putting more than a small allocation to real estate or cryptocurrencies.

In this context there are still a few places where value is still sitting in plain sight. Within financials and in particular banks, 4 strategies currently stand out.

To be clear, don’t expect these strategies to be popular. In particular banks are still seen as depressed due to rates and technological innovation outside the sector (this conventional wisdom is actually correct in many cases but those situations are easily avoided).

Also, don’t expect these strategies to be highly liquid. If you aren’t investing large sums, why compete with managers investing $100 mln+ a year in staff and data like Point72 and Renaissance?

Finding value in the bank universe.

1. Buyback trades
2. Embedded technology
3. Consolidation targets
4. Index rejects

1. Buyback trades:

Take a bank earning 7% ROE with 11% capital, and trading at 90% of tangible book. I’m using the example of an actual bank. The CEO knows his ROE is too low and his capital is too high. The CEO also knows that one way he can help fix both problems is to repurchase his shares.

Bonus #1: this bank’s EPS benefits from this as well if he carries excess liquidity, which 90% of banks today are dealing with.

Bonus #2: These banks tend to outperform in volatile markets due to the presence of a large, consistent buyer

There are 10+ banks currently repurchasing under tangible book value.

2. Embedded technology:

About 50 banks around the country are ahead of the curve on real-time payments and supporting alternative banking channels (neobanks) with compliance and balance sheet. The rest of the sector considers a digital strategy to be video tellers and online account openings – not exactly door busters for customer acquisition.

Of those 50, several are private, about 10 have been discovered and bid to lofty levels, and the rest are too small or too early stage to be popular. In these situations, investors own the rails, and much of the derivative fee-sharing income, for the exploding neobank subsector (Neobanks in North America in 2020 | NeoBanks.app). Almost every public example of these “Banking as a Service” banks trades at a material discount to the broader market.

3. Consolidation targets:

The bank merger topic has been covered in this blog before. Any fund manager investing in banks must stay on top of who is incented to partner up when 50-70% premiums are common.

4. Index Rejects:

The Russell 2000 must make room for 50+ IPOs and SPAC mergers. Out with the old (banks), in with the new (an endless list of payment software startups and green energy technologies).

One of the deleteds runs a 35% efficiency ratio, consistently returns 20% ROE, and trades 8x earnings estimates that look conservative. While the company’s ROE and EPS growth are behind Amazon, Nvidia, and Netflix, it is not by much.

There are approximately 80 banks that stand to leave the Russell 2000 index at the end of June.

Disclaimer: Colarion LLC (www.colarionpartners.com) is an advisory but cannot give advice to the public in this forum. Therefore this note is educational because it has not been customized to your situation.  Any discussion about future results or projections may not unfold as expected.  You should engage in your own research and / or speak to a licensed advisor before making any investment decisions.  Colarion may be long or short shares of any of the companies mentioned in this report (MFNC).