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

by | Oct 13, 2020 | Corporate Governance | 0 comments

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:

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.