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Feature: Small Banks

In the previous Issue, we ran a feature called “Small Bank Snapshot,” wherein we presented what we
thought were two small bank ponds that were worth fishing in – a “cheap” one with low price to
tangible book value and also a “quality” one with higher return on equity banks at reasonable prices.
That Issue was published on August 13th, and as you have probably seen over the succeeding several
months, bank stocks have been rocketing higher. The S&P Regional Banking ETF (KRE) is up about
25%, and the First Trust NASDAQ ABA Community Bank Index Fund (QABA) is up a similar
amount. As the sector has rallied, a lot of the banks mentioned in that snapshot have gotten more
expensive. So in this feature, we will flag some that are still potentially cheap.

As Nate mentioned in his opening letter, this is a space where there appear to be some bargains. As
long as covid goes away (either through vaccination or herd immunity) in the early part of next year
and borrowers who have deferred resume their normal payments, the current valuations will look
cheap. There are certainly many bankers feeling sanguine about their loan portfolios given the
astonishing number of share repurchases that have been conducted or announced by banks this fall and
winter. Profitable companies buying back stock is a great sign, but we should always question why we
are being presented with an opportunity that appears juicy. Perhaps the explanation is in something that
Gator Capital wrote about in its October letter; a lack of generalists interested in the bank sector:

The community of institutional investors who focus on bank stocks has struggled this year.
Many bank stock investors focus on small-cap banks with less liquidity. We observed forced
selling by this group of investors from March to September as these funds had to raise cash to
meet investor redemptions. In talking with other bank investors, there is consensus that bank
stocks are cheap, but everyone is already fully invested. This community is looking for new
capital to put to work.

Last Issue, our guest writer “Catahoula” mentioned Carter Bank and Trust (CARE) based in
Martinsville, Virginia with $4.2 billion of assets. It currently has the biggest drawdown from its 52
week high (-59%) of any bank stock that we follow. It has a $261 million market capitalization and a
tangible book value of $427 million (0.61x P/TBV) which is one of the biggest discounts to tangible
book value, especially for a bank with a market capitalization above $100 million. Their most recent
NPA figure was around 1% of assets.

The big concern with Carter, and the reason for the big discount, is that the bank has a portfolio of
loans to hotels. A couple of weeks ago, they published a loan deferral update, showing that their loan
deferrals have declined from $1.2 billion (41% of loans) on June 30 th to $388 million (13% of loans) in
mid-November. Of these remaining loans, 70% were projected to make interest payments but defer
principal until the end of 2020, and 30% of them were projected to defer both principal and interest
until the end of the year.

Carter disclosed that most of these remaining deferred loans are hotels, all of the hotels are open for
business, and quite a few of the loans that needed continued deferrals were new construction or
undergoing renovations immediately prior to the pandemic. The presentation is helpful and well worth

Copyright Oddball Media, LLC 2020 ISSUE 32 (November 2020)

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reading. This could be an interesting one to dig into depending on your view of how close we are to the
end of the pandemic.

Speaking of greater than $1 billion asset banks trading at big discounts to book value, another one that
we have mentioned in the past is Bank of Utica. This bank is an extreme outlier in terms of its discount
to tangible book value (trades at 0.4x TBV) and its over-capitalization (TBV is 22% of total assets). It
is simply ridiculous that management does not use excess capital to buy back stock at such a massive
discount – but we now have an inkling as to why. See the Company Updates section in this Issue.

In the previous Issue we mentioned one of Joe Stilwell's picks for his activist bank fund: U & I
Financial Corp (UNIF), the holding company of UniBank, which targets the Korean-American
community in the Puget Sound metropolis. When we mentioned it last Issue, it was trading at 73% of
tangible book; it has rallied a bit and is currently trading for 0.82x. This is a smaller bank with a market
capitalization of $56 million, $380 million of total assets. Lately it has been earning over 10% on
equity. It also has plenty of capital: equity around 15% of assets. We have to imagine that Stilwell
thinks they should buy back some stock, and we would agree.

A similar bank is First IC Corporation (FIEB) which owns First IC Bank. They are based in Georgia
but they have opened up branches and loan offices in other Korean-American communities. (We will
call this emerging category the “K-Banks”. According to SNL, other K-Banks would include BBCN,
HAFC, WIBC, PFCF, CWBB, OPBK, OHPB, and USMT.) Anyway, FIEB is trading at half of tangible
book, earning 9% on equity, and has Tier 1 capital of 14%. Notice that with these huge discounts to
book value and respectable ROEs, these banks have very high earnings yields. Based on its year-to-date
annualized earnings, First IC is trading for under 6 times earnings! It is worth thinking hard about covid
and credit risks, but you also have to ask how much risk is already priced in at these valuations.

An area of the bank sector where we have been closely focused is the banks that are aggressively
repurchasing shares. In Louisiana, Eureka Homestead Bancorp Inc. (ERKH) is a former mutual
(founded in 1884) that IPO'd in July 2019. This is a small, OTC listed bank with a market capitalization
of $16 million trading at 68% of tangible book. With $100 million of assets, it has significant excess
capital. From the beginning of this year through the third quarter, they repurchased 8% of their
outstanding stock – at a sizable discount to book value. Profitability for this bank wavers between
breakeven and slight losses, but we like seeing a mutual at a big discount to tangible book that is doing
significant share repurchases a year after its IPO.

On October 29th BankFinancial Corporation (BFIN) announced that it was going to “Extend and
Expand [Its] Share Repurchase Program”. This is the sectoral activity that is getting us interested in
banks: profitable, at discounts to liquidation value, well capitalized or overcapitalized, and buying back
stock. BFIN has a $124 million market capitalization, trading at 72% of tangible book, on track to earn
about 5% on equity this year. But very importantly, it has 18% Tier 1 RBC capital and only 0.15% of
assets non-performing. With that valuation and that much excess capital, and a management inclined to
repurchase shares, there seems to be a good chance that shares recover to where they were pre-covid.
We also very much like the signal of bankers announcing share repurchases – not just the implications
for individual banks but for the sector as a whole. They can see what is happening with their borrowers
and they have decided to spend capital on accretion instead of hoarding it.

Copyright Oddball Media, LLC 2020 ISSUE 32 (November 2020)