Charting Banking Series Intro
by PlanMaestro
“We worry top-down, but we invest bottom-up” – Seth Klarman
Despite its name, this is not a series on Technical Analysis. I think it is time to share some nice graphical data, result from a lot of time spent recently analyzing banks, that tell some underappreciated, misrepresented, or difficult important facts on the strength of the industry. Most of these graphs are from companies that I do not have and even some of them will be from companies that could be good shorts. So just the facts.
The streetcapitalist has a great interview with a bank analyst that raises some very good points on the suitability of this industry for value investing. The black box nature, leverage, and thin margins can look more suitable for speculative plays:
In Margin of Safety, Seth Klarman says that value investors don’t invest in banks often because their asset books are too opaque. How, when you’re analyzing a bank, do you make sure the assets have a credible margin of safety?
It depends on a lot of factors. 1. The types of loans and geography 2. How loans are performing. 3. Management’s track record in originating loans and honesty. 4. How the macro is performing and 5. How aggressive/conservative management is in working through problem loans.
So dealing with the transparency, that’s a good question. Investing in financials is more of a gamble than any other category. You will simply not have the transparency you have at other simpler businesses. In other sectors management on conference calls can give you line item guidance that you can just plug in your models to come out with next quarter EPS within a small range of error. How many financial management teams got it wrong or thought they wouldn’t be the last one’s holding the bag during the crisis? I remember hearing Ken Lewis (CEO of Bank of America) talking about how the recession will end in 2Q08. And this guy basically gets a real time update on the economy on a daily basis.
So you want a wider margin of safety. If you would buy a company at 6x P/E, you might want to aim for 4x P/E.
Financials are truly a different animal in my opinion. There is no advantage in investing in financials (meaning you are not getting superior moats or higher ROE businesses compared to other sectors) If you thought the market was dead cheap in march for example, there were plenty of businesses in plain vanilla sectors (retail) that had rises greater than or similar to financials and were much easier to understand. Assuming these stocks were undervalued and haven’t gone up for speculative purposes, you can see that car rental company Avis Budget Group (NYSE: CAR) is up 11 fold since its low compared to Bank of America which is up 6x. I would say Avis is a lot easier to understand than BoA.
So why did value investors get it wrong?
As a value investor, investing in a financial requires really getting comfortable with the macro-economic situation. So unless you’re doing some kind of arbitrage (market-neutral) play, you will have to look at the macro. If you want to ignore the macro because Warren Buffett says it is useless then you want to stay away, especially if you’re not benchmarked or don’t have a mandate to invest in financials.
The thing is that now banking microeconomics has become the developed world main risk. With banks and shadow banks being the main channel of credit, and with a government every day more limited in its options, it is clear we need a healthy banking system… and I worry.
And since the sector interconnectedness and fragility is the main driver of the credit cycle, this is a critical issue to follow in a top down risk analysis. I would argue that to understand the risks and the probabilities of a revisit of the March 2009 lows, a rapid recovery, or a range bound market it is important to understand the health of this industry and have a view on it. And if these analysis bring some collateral bottom up opportunities even better.
Looking forward to this.
Have found some good value opportunities in banks, but generally on the smaller end of the spectrum.
Screening for microcap banks that earn positive ROE low p/b and pay a dividend seem to be one way to play it. After that its a matter of picking through and seeing what their loan portfolio is like and if they will face late-stage credit probs.
Thanks Tariq, let’s see how this goes. What I am battling with is to get a screener where I could use pre-tax pre-credit income. When they get to a positive ROE already the banks are close to 1x TBV, cheap but not mighty cheap. I have also found a couple of nice opportunities where the FDIC has pressured them to cut dividends. The rumor is that they want to capitalize them to lead the integration of failed banks.
It is difficult to navigate this with the regulatory capital pressures and potential dilutive equity capital injections. Tom Brown’s article today on PFBC, a bank that I have high on my wishlist but have not bought yet, is excellent
Tarig, I think positive ROE is less important than high reserves. If a bank is aggressive in working through its NPAs, it may report higher provisions, and results in negative ROE, but when we see allowance/NPA over 50%, we know it is probably going to be enough to cover the losses. But for the same bank, if management is conservative, they may report positive ROE, and tiny provisions.
Hi Plainmaestro,
Nice to see your blog here! Two weeks ago I met Jae and he said you are really great in analyzing banks, so here I am.
Right now my strategy is to pick banks with positive operating margin, price/adjusted book value < 60%, taxes ratio < 0.4, nonperformers 30%. Adjusted book value is to deduct goodwill and other intangibles, and discount the securities they have if it is not backed by the US government, and from zillow.com, the local real estate market had better been going flat or at least is significantly slowing the drop.
In this way I picked BKOR, CEBK, CRFN, CWBC, FBIZ, LSBI. I am wondering if there is any other criterion for selection banks that I need to pay attention to? Last week, quite a number of banks that I decided to pass have gained 50%-100%. Some of them have over 6% nonperformers, and some of them have negative ROE, so I didn’t buy those.
I am wondering whether instead of positive ROE, maybe positive FCF is a better choice?
In addition, when I walk through the banks’ net income statement, it seems to me that gains from securities sold, or gains from securitization of loans is a faked income that should be deducted, just like for manufecturers, gains from PPE sold should be deducted to assess the real quality of earning?
Thank you!
Zehua
So adjusted book value is very close to a price to tangible common equity. 60% is very aggressive, there are probably some out there but if that is the case I would check in particular if they have substantial Construction and Development loans (C&D). Those are very risky because they do not generate cash, mature short term, and the collateral value has declined substantially in most states. Given that investing in banking is part investing in a black box, you can never be sure of how good are their loans, I try to avoid the ones invested in the riskier sectors and now that is C&D.
Give me some time to check the ones you mention.
CEBK: had looked at it, but its pretax preprovision earnings (PTPP) was not good, $2.8 million at the most for a P/E of 6 (not very cheap). Part of the reason may be that it was too small to have expenses scale
BKOR: Same profitability issues than CEBK and 22% of loans are C&D
CRFN: So many good things, but the 23.6% in C&D and mixed record of insider buying makes me pause
CWBC: Well capitalized and reserved with insiders buying: looks very good at first sight and I am not sure why it was not in my target list. Might be worth an inside look at their 10K. Things that worry me are that the NPAs and delinquencies are growing, and it looks like the business mix is not tipical for a community bank
FBIZ: Another interesting one that might be worth a deeper look to the 10K with some insider buying including the CEO. CRE might be the market concern with this bank, but mi impression after studying several bank is that this issues are overblown. C&D is the real issue in the sector, and for this bank is only 7.5% of loans
LSBI: CEO buying and given that it has no preferreds nor goodwill the 9.1% equity to assets looks very strong (with good NPAs and allowances) but that low leverage may have been the reason for its historic low profitability. With a reasonable 11% C&D I did not find any red flags at first glance so it is also worth an inside look
Waiting for your comments Zehua
Thank you.
CEBK’s local market is boston metro. It has only 8 branches, so indeed very small. However price/book is quite good, only 60%, and it is still making some money.
When you say $2.8 million at the most, which year is that? In 2006 it is over 4 million. In addition I checked zillow.com, and boston metro’s real estate is already 15% up year to year.
BKOR’s C&D seem to be conservative, and I guess this is true as their NPA is low. Below is from their recent 10Q:
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Construction Loans. Another of the Bank’s lending concentrations is construction/development lending. However, the Bank, like many other financial institutions, has greatly decreased its emphasis on this type of lending over the past two years. The Bank originates 1-4 family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of homes. The Bank finances “starter” homes as well as “high-end” homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside banking entity prior to financing the construction of pre-sold homes. The Bank makes construction loans to builders of homes that are not pre-sold, but limits the number of such loans to any one builder. This type of lending is only done with local, well-established builders and not with large or national tract builders. The Bank lends to builders in its market who have demonstrated a favorable record of performance and profitable operations. The Bank limits the number of unsold homes for each builder. The Bank will also finance small tract developments and sub-divisions; however, the Bank seeks to be only one of a number of financial institutions making construction loans in any one tract or sub-division. The Bank endeavors to further limit its construction lending risk through adherence to established underwriting procedures and the requirement of documentation of all draw requests. The Bank requires personal guarantees of the principals and demonstrated secondary sources of repayment on construction loans.
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For the other banks yes, I totally agree with you on the pros and cons. I think their current NPAs are all below 4%, which seem to tell that the large portion of C&D is not that big concern, unless they are all very conservative in recognizing their NPAs.
How do we tell if management is agressive or conservative in recognizing NPAs?
Look at the past, when did they start recognizing issues. Marshall & Isley for example was one of the first recognizing problems and took a bad rap even though their problems were not worse than the rest. When I see a bank with low tangible common equity, in a bad region, with a concentration in not the appropriate risks, with delinquencies climbing, and with too good to be true low NPAs, I take as a sign of potential problems to come.
CRBK: I did look at previous years, check if there was no one time gains. And if you check the last two years they do not look very good.
CRBK: I did look at previous years, check if there was no one time gains. And if you check the last two years they do not look very good.
Do you mean CEBK? One time gain means other income, such as gains from securities sold, or gains from branches sold, right? I once looked at STU, and their most recent 10K has a large other income item called securitization of loans. This should also be considered one time item, and be deducted right?
Thank you very much for the Marshall & Isley example. I will look at that one’s previous years.
When you said low equity, do you mean something like below 5%? What about too good to be true NPA? Like 2%?
Yes to both questions
What is CRE?
Sorry, Commercial Real Estate
I think CEBK was doing well in 06 and 05. In 07 and 08 not many banks are doing well right?
Now CEBK’s net interest margin has improved over last year to 3.35%, which I think is also good.
I sold BKOR today with a tiny profit. I think you are right. I didn’t check its earnings in the past.
You seem to have a strong emphasis on insider buys. Do you buy stocks that no insiders have been buying for the past year, such as BYFC?
Given the black box nature of a bank’s loan book there you can limit the risk but not completely eliminate it specially in a small bank like BYFC. Insider buying is one of the ways to limit that risk.
I see. Thanks!
I found that earlier this week in your twitter, you updated CRBC: CFO resigned same day shareholders meeting citing end of turnaroud, will probably drop anyway. What to do?
I do found on google news that the CFO is leaving, but I can’t find anything about citing end of turnaround. Would you please tell me where you found the news?
It was in the official press release, do not remember where (8K, marketwatch, businesswire)
If a bank’s insiders have been buying a lot for 2008-2009, but no recent insider buys have happened within the past 6 months, then do you still consider it as insiders buying? Such as MCBF.
This is what I have on my notes on MCBF and I think it will answer your questions:
“credit issues should be behind (primary home mortgage and delinquencies going down), but given that it is a small bank, they have ARMs (!!!), credit ratios are still deteriorating and there is no insider buying, it is better to wait for confirmation of better credit risk”
Thank you so much. Could you please tell me why ARMs are not good for small banks?
When you say credit ratios are still deteriorating, do you mean the NPA ratios and allowance/NPA?
Would you please take a look at RVSB and FBMI? FBMI seems strong. RVSB is not as good as FBMI, but they are working through the NPAs aggressively, and all kinds of ratios seem great, and their NIM is 4.5%, that is quite higher than other banks I have seen.
To tell you the truth I have not gone into the details on how ARMs and option ARMs in particular will reset. There is a general consensus that they are more risky because they were issued to more risky borrowers and some of them had teaser payments that did not include principal amortization
BTW, I have FBMI and passed on RVSB (do not remember why) FBMI have been reducing its dividends in small steps … almost a Chinese torture. However, its numbers look very good specially being in Michigan.
My concern is that their land loan is 10%, and “speculative construction loan” is 5%. I have never heard of the term speculative construction loan. They seem to try to separate this from “good” construction loans?
Thank you PlanMaestro. Would you mind sharing a few other banks that you own? I apologize if this is not appropriate.
I am preparing a post on that, maybe next week
Any opinions on companies in the student loan sector, such as NNI and SLM? They are two of the four companies that will continue to serve the federal student loan area after July 1st.
NNI looks cheap for now, but I am trying to figure out how much it will make after July 1st, it looks like some income fees will disappear after the new law takes effect. I looked at the income statement, but couldn’t figure out how the new law will impact each of those items. Would you be interested in taking a look?
Would love any recommended readings, do not know much about the sector and future government involvement
Would you please take a look at FCAL? It seems to have high reserves, and NPA is steadily decreasing. C&D is also pretty low.
It is currently trading at around 70% common book value. I think I would buy when it drops to 60%. What do you think?
Very interesting, I had dismissed because I checked it before the new equity and recent NPA developments. Nice presentation by the way.
http://www.snl.com/Cache/1001152642.PDF?D=&O=PDF&IID=100349&Y=&T=&FID=1001152642
Shoot me an email to variant dot perception at gmail dot com to discuss it in more detail.
Perhaps my only comment would be some skepticism on their earnings power but at 0.8x tangible common and solid capital ratios is FCAL one definitely to consider
I sent you an email but never got reply. Anyway, the pretax pre provision interest income for FCAL is about 2.5 times P/E. Not very bad. So why do you say its earnings power is not very good?
Would you mind taking a look at FDEF? That seems a good one, too. With CEO and CFO buying. I am not comfortable to buy at current price though.
Have you found any euro banks that are screamingly cheap? With current euro crisis, I bet there would be some really good banks trading at 30% P/B, but I haven’t found one yet.
Sorry did not get it:
FDEF: I have a small position and was considering making it a main one after last week sell-off. I a particularly like their PTPP earnings. They are hitting it out of the park
FCAL: Post-dilution?
Europe: Investing in banks is not just pure value investing, you need a handle of the macro. I can not say I do with Europe. Waiting for a real crisis to dive in. I have IRE, AIB, NBG in my watchlist.
I am confused about the euro crisis that seem to have a high media exposure only recently. Hasn’t this high debt problem already been there since last year?
Japan has had debt/GDP ratio of 200% for many many years, but still no problem there. So is this really a big problem, or it is just an excuse found by the media for the recent bear stock market?
The problem is not of high debt, not even of high deficits. The problems is that the euro is a straight jacket that restricts its members for individual currency adjustments to adjust to individual shocks. Labor does not move as easily in Europe as in the USA, so now Greece has a deflationary problem consequence of high labor costs with low productivity. Greece and the other Mediterranean countries are trying to manage it through government cuts and debt restructuring but this is a very painful process, that could take years, for not so clear benefits.
The banks under scenario are under a big threat, and given that there is a significant possibility that one or more of this countries leave the Euro zone the the situation is even more risky. In that scenario there would be probably runs on the banks. An excellent book analyzing what happened in the very similar Argentina 2000 scenario is The Money Kept Rolling In
Thank you! I got it now.
Regarding FDEF, I still think it is a bit expansive. I am adding more positions to FBMI these days as the share price keeps dropping, and as the second largest banks in Michigan, it seems to be in a better shape than CRBC. What do you think?
I am not getting the FBMI selloff, was planning to do more work and maybe making it a core position. I still like FDEF and CRBC, both are larger banks with higher visibility for when the turnaround is clear
Below is from FBMI’s latest 10-Q. Looks like it is a solid movement.
I reviewed my other bank stocks, and I bought those ones too early, and their NPA is still increasing, so I decided to sell them at a small loss.
If you are interested in buying more FBMI as well, would you please tell me what kind of additional work we can do here? I would be happy to do those investigations.
So right now, would you mind sharing the most promising banks that you think are?
I know you have CRBC and FDEF. Any other ones?
(Dollars in Thousands)
March 31,
2010
December 31,
2009
Nonperforming loans:
Nonaccrual loans
$ 31,972
$ 30,677
Loans 90 days or more past due and still accruing
1,574
7,106
Renegotiated loans
1,968
3,221
Total nonperforming loans
$ 35,514
$ 41,004
You might want to take a look to SNBC, NBBC, VIST, ASRV, TNCC, LNBB, UCFC. Just one condition, tell me what you think of them
Also IBCP, FBC, are interesting but they need more in depth analysis to understand the consequences of the capital injection and dilution. PCBC might be another one after it becomes clear if they will get the capital plus the trups and government concessions.
[...] with good track records below 1x book value. But before getting too excited let me remind you the warnings about investing in banking and in financials in [...]
I heard Buffet recently talked about the dangerous positions of municipal bonds. Some of my banks, like CRFN has a big position in municipals, plus you said its 23% C&D loan is pretty risky. I am thinking of selling at a loss for this stock now.
Hi PlanMaestro, I am a bit worried about the following problem:
If I bought a 300k house in 2008 and put down 200k, I have 100k equity. Then I take a home equity loan of 100k, and then just use that money to pay my first and second mortgages. The bank will view these two as a good 200k and 100k loan. Then in 2011 when I run out of money, suppose my home value drops to 150, then the bank will suddenly get two bad loans.
As an investor, how do we prevent these kinds of problems? I think banks call this kind of loans to be impaired loans, but they only evaluate CRE impaired loans one by one, and collectively evaluate residential and consumer loans, therefore the problem above cannot be identified by them, right?
UCFC has 7.59% NPA.
LNBB’s NPA is higher in 2010Q1 than 2009 Q4 so I’d like to wait a few more quarters.
SNBC has 25% of municipal bonds, which makes me feel unsafe. Buffet is predicting a serious default in municipal bonds. In addition, it has no disclosure about 30-90 day delinquencies and C&D loan percentage.
NBBC: texas ratio nearly 50%, and 100 million municipal bonds. No disclosure on 30-90 day delinquencies.
VIST: No disclosure on 30-90 day delinquencies. Have not found anything else that keeps me away.
ASRV: Historical low profitability.
TNCC: We need to see exactly how many shares they are going to issue in the most recent S1 form. NPA is increasing.
I have nothing to add to the munis issue, it is not something that I have studied. Any interesting sources?
LNBB: Remember, the important thing is that the Texas ratio stabilizes, so if TCE+reserves are improving faster than NPAs are increasing, and if 30-90 delinquencies signal stabilization it might still be a good buy
SNBC: http://www.bankregdata.com/bkAQmet.asp?met=P30&inst=HC1139242
http://www.bankregdata.com/bkLD.asp?inst=HC1139242
3090del exploded 2Qs ago, but low C&D and right direction of other indicators
NBBC: you can check 30-90 delinquencies at bankregdata. This is for NBBC, http://www.bankregdata.com/bkAQmet.asp?met=P30&inst=HC1076002
VIST: same like others check bankregdata
ASRV: it is an average bank, is not like FDEF’s preprovision earnings= . But looks cheap
TNCC: true, but I like how pre-tax pre-provision earnings are exploding
http://www.tradingmarkets.com/.site/news/Stock%20News/2213340/
This is the news about Buffet’s comments on municipal bonds.
On the links you gave me, could you please tell me what the color means? Some diagrams are red, some are blue and some are white. Looks pretty confusing to me.
It is confusing, you have to know what you are looking for and stick to it.
Thank you so much for the info!
I checked that site. It seems like FBMI has much better asset quality than most of these banks, and its price/book also provides better value.
I would be really curious about the Texas and New England bank crisis in 1980-1990, and see if once the 30-89 day delinquency starts to go down, it won’t go up again.
The government put so many economy stimulus plans after the crisis, and now they start to lose effect. I am worried if this number can go up again, especially considering the recent news that local municipals start to lay off governmental workers, which is unheard of in the past 50 years?
SNBC’s 30-89 day delinquency suddenly exploded in the last 2Qs. That is my concern with other banks. How do we know if it has already peaked, or it is going to give us a surprise later?