Hi everyone,
Since working for this small-cap equity research shop, I’ve been fascinated with thrift/community banks, particularly ones that have gone through conversions. The value proposition behind them seems so obvious (many trade below tangible BV) and they’re often underfollowed.
Does anyone know other industries/sectors where the value proposition/upside is presented as obviously as mutual thrift conversions? Thanks!
Its amazing how many of those community banks with public equity are out there. Pretty interesting. There is probably some money to be made through good DD. You’ve gotta understand their loan books, though, if you’re investing based on book vs. market equity valuations. I imagine the management teams at some of these banks vary wildly in competence.
I think banks may be the best industry for this. A few reasons why. One there are a lot of them below the size most funds can play, so pricing distortions occur frequently. Two they are regulated and have to disclose a ton of data every quarter, which increases insight into what is going on. Third, outside of making bad loans, community banks are not volatile businesses. It’s not hard for a bank to stay in business hundred years. It’s just whether the growth and profitability can be achieved. But there is no dependency on one customer for revenue or inability to get demand. Finally banks have been consolidating and M&A in the space is almost daily, so undervalued banks are highly likely to be taken out. I think other microcap businesses for the most part are much more volatile and less predictable
I looked at a few of these while on vacation and I didn’t find many of them that were trading below book value, so I’m not sure which ones he was looking at. Some of them appear to be well-run, easy to understand banks that shouldn’t be too difficult to value. Lots of residential and commercial real estate loans
The majority of community bank stocks are extremely illiquid and virtually impossible to buy, so the “discount” is often just a liquidity spread. Some are buyable of course but there are hundreds that aren’t.
Within small caps, excluding obviously stupid pockets of the market like the biotech fraud bubble, banks were one of the few indistries that held up well as an entire group this year. We looked and the average community bank trades in the 1.1-1.3x TBV range with 8-9% ROE. You are signing up for a structurally low return if you buy a bank with that math. Out of the hundreds, there are certain to be some values, but the trade really happened a couple of years ago. The easy money has already been made.
^ Well said. I looked at a few of the larger ones with market caps in the $100MM to $200MM range and they didn’t look to be value opportunities. I think you summed it up well. Not much opportunity here.
I’d stay away from the smaller ones that appear to be values. The financial reporting is pretty terrible if you’re even fortunate enough to get quarterly statements on them. In regard to the smaller ones, I don’t know how they get quality management that knows how to manage credit and interest rate risk.
That’s true. The smaller ones at a discount are often broken. There are some good activists you can coat tail if there is enough liquidity but again, that trade has largely already happened.
We’re long CFG and BAC, could probably be long RBS if we wanted to sign up for a slow grind. Those are cheap but not small.
I think Bro is correct about liquidity and the trade already happening, outside of potentially oil exposed banks. In terms of management, it just depends on the size of the bank and type of lending… Most small banks are run by former lenders, so the credit is normally their strong suit. Interest rate risk isn’t that big a deal most of the time. The opportunity in the space is through consolidation currently. One fund who specializes in community banks for twenty years now has done well picking takeout candidates. I think they were involved in almost all the meaningful deals this year. But this requires being able to judge management willingness to sell, which may be hard for a non fund. And what do you mean the financial reporting is terrible? Banks, both public and private, have to disclose more data than some do in their Qs. Unless you mean the accuracy of that data, which then I’d agree somewhat for the very small guys. I read this morning there is a new activist fund being launched to specialize in community banks. I think most are getting sick of waiting for interest rates to rise and profitability is a function of scale for smaller guys. Lots of fixed costs disappear in a combination
I ran a screen quickly in SNL and I are 74 trading below book with average daily volume of greater than 1000 shares. The list reminded me that one place investors seem interested is the Puerto Rico banks. I forget which one all the “snart” guys love, but who knows how long it’ll take for the economic uncertainty there to get fixed.
If you get into the $50MM-ish and lower market cap community banks, I found a fair amount of them that didn’t have quarterly filings. A few of the quarterly filings weren’t 10-Q’s but very simple files that looked like they were made in QuickBooks. If you can get 10-Q’s, that’s great.
Aside from regulations, plain vanilla banking has been a very easy business for the last five years w/ low defaults and an upward sloping yield curve. I stand by questioning management at some of these small community banks. Prudent credit underwriting and managing interest rate sensitive assets and liabilities isn’t simple. There’s a lot of poor management even at the large regional banks. You can get away with poor underwriting and ALM in the environment we’ve had the last five years but that won’t last.
That said, some of them look to be legit, well-run financial institutions but I don’t think they are attractively valued for new investment.
^ Good points Tommy. Nothing makes me more nervous than obvious investment opportunities.
You can be sure that the quants arb out the obvious stuff. It’s not as though no one is looking for that. They find them automatically. What’s left is trash. You can buy some FOSL for “7x earnings” (seems legit!) but I wouldn’t recommend it.
re: banks, you should look at average daily dollar volume, not share volume imo
The concentration risk of a community specific sub-$50mm book value bank makes my head spin.
What I mean by “obvious” isn’t surface-level obvious, but moreso opportunities where the risks are more focused and observable. It seems like most of you guys are skeptical of the industry. If that’s the case, any suggestions for other industries or special events that provide opportunities with higher-than-average conviction?
I tend to see investment ideas that are dependent on the success of a lot of moving parts, which I find riskier because just one aspect that goes wrong can potentailly throw off the entire thesis.
^ Infrastructure plays with reliable long term cash flows trading significantly higher in yield (equity) than their counterparties.
howard marks has a sizable position in FBP, as does the US treasury. This thesis falls into the discussion - however, lots of uncertainty here. Historically they have gotten non-performing loans off the books quickly, however not well versed on the recent story (closed my position in early 2015).