Reliance Bancshares, a turnaround that's actually turned around

A big secret in investing is that turnarounds usually don’t turn around.  Companies in the midst of a seismic business change often don’t make it through to the other side.  The reasons for this are numerous but one of the most important factors is management.  The management of a company that falls into a mess is usually the wrong team to get a company out of a messy situation.

At times a company might realize that they are outside of their capacity regarding a turnaround and they bring in outside management.  It’s in situations like this where things get very interesting, such as with Reliance Bancshares.

Reliance Bancshares (RLBS) is a holding company for Reliance Bank located in St. Louis, Missouri with two branches in Ft Meyers, Florida.  They have a market cap of $154m, and have slightly over $1b in assets.

The financial crisis was not kind to Reliance Bancshares, the company’s results from 2009-2011 were horrible.  The bank lost $21m, $31m, and $29m in 2009, 2010 and 2011 respectively.  Non-current loans to loans rose from a pre-crisis .81% to a high of 15.33% in 2010.  In 2011 they charged off 3.5% of their loans as they worked to clear out their troubled loan book.

As a result of their operational problems the bank was given a Cease and Desist order from the Office of Thrift Supervision (OTS), and later a Consent Order by the FDIC, the successor to the OTS.  The orders directed the bank to cease dividend payments, cease share buybacks and improve their capital position.

The bank's management at the time realized that they were out of their element and brought in an outside banking consultant.  The consultant was Thomas Brouster, a banking entrepreneur who had previously turned around 14 banks.  The company's management eventually promoted Brouster to the position of CEO.

The Consent Order from the FDIC directed the bank to raise capital, which they did.  They raised $31m in an equity offering led by Brouster.  Brouster came away with a majority ownership position in the bank, and the bank ended up with $24m in capital, raising their Tier 1 ratio above 10%.  The rest of the capital was held at the holding company.

Brouster did what he was known to do, he stemmed losses at the bank and returned it to profitability.  He did this by reducing costs, lowering deposit costs and growing the bank's loan book.

The biggest drag on the bank's earnings has been their cost of deposits, the picture below show how much they were paying historically:

In 2010 the bank was paying 1.84% for their funding, a value that's dropped to .77% in the most recent quarter.  High funding like this is a sign of a bank that uses costly brokered deposits.  Reliance Bancshares was a pig at the trough with hot money going into the financial crisis.  In 2008 they had $168m in brokered deposits and $808m in time deposits.  As of the most recent quarter the bank has $8m in brokered deposits and $324m in time deposits.

Fast forward to the most recent quarter, the bank earned $2.08m pre-tax and $38m in net income.  A difference like this merits further investigation.  Their large one time gain was a result of a reversal of a valuation reserve against their deferred tax asset.  As banks generate losses they book those losses into something called a deferred tax asset to be used at a future point to offset future gains.  If it seems unlikely that a bank will be able to utilize this asset the auditors require the bank mark down this asset.  The reversed valuation allowance amounted to $36m.

Along with expense reductions, and lowered deposit costs Brouster has also been at work growing the bank.  In the second quarter loans grew 11%, and deposits grew 2.4%.  Additionally the bank's non performing assets have continued to drop, and they've now had 28 months without a loan more than 30 days past due.

Reliance Bank is not only working on expanding their loan book, they're expanding their physical presence too.  They recently closed on a piece of property in St. Louis proper, and are working on constructing another branch in the St. Louis suburbs.  Both of these branches should result in increased deposits and lending.

The bank is clearly on the mend, they earned more this past quarter verses all of last year.  If they can continue to decrease expenses and lower their deposit cost earnings will grow, even without loan growth.

The obvious question is what is this bank worth?  That's where things get interesting.  The bank isn't cheap on any classic valuation metrics.  Their book value is $1.78 per share, and tangible book value is $1.22 per share.  This past quarter they earned $.02 per share.  Let's assume they can earn a similar amount over a year for $.08, they'd be trading with a P/E of 25.

A better way to model the bank is to look at what their ultimate earning potential is given their assets and work from there.  If the bank can continue to reduce their expenses and deposit cost maybe they can earn 1% on their assets.  Under that scenario they'd be earning $10m per year, or $.13 per share.  A 10% reduction in expenses could lead to $2.1m in savings, a 25% reduction in expenses could lead to another $5m in savings.  With the bank's substantial tax loss carry-forwards these savings would fall straight to the bottom line.

It's possible the bank will grow into their valuation.  Maybe they can dramatically reduce expenses beyond my 10% estimate as well as increase lending with their new branches.  Regardless, Reliance Bancshares isn't a typical value investment, but I can imagine a number of scenarios where if this bank can execute on their growth plans that one might consider this price cheap.

In the end this isn't an investment for me, but I'm sure this is something a few readers will be able to benefit from.

Interested in learning more about banks? Buy my book The Bank Investor's Handbook (Kindle and paperback available)

Disclosure: No position


  1. Another good post, Nate.

    Let me ask you this though: Why do you say this isn't "an investment for [you]"? Is it mainly because it isn't a traditional value play?

    1. Great question. The reason I'm passing is because too many assumptions are needed to justify the valuation.

      If this was a classic less than P/B bank one or two simple metrics could validate BV. In the case of Reliance a somewhat complex model is needed to show the bank growing into their valuation. I didn't put it in the post, but I did do the modeling on my own before I wrote this. It's not difficult to bend the numbers to justify this, but the problem is a lot of things need to go right.

      I prefer to invest in companies where instead of things needing to go right I need things to not go wrong.

  2. Just to make it more explicit:

    If it WERE trading at 0.6 TBV or less, would it be just comfortable enough for you to invest, or are the operational metrics still too speculative and insufficient?

    Thanks for the write-up.

    1. No, most likely not. What I did was put this through a M&A model I have plus a few other earnings models. I couldn't get the valuation to match their operations outside of extraordinary conditions. So unless the bank grows a lot or becomes a lot more efficient I couldn't get the numbers to work.

      It was a pass based on earnings, nothing with book.

  3. Great post Nate,

    Just wondering, what are your thoughts on Yahoo? I realized that your forte is in deep value, net-net, Graham kind of stocks. But what about arbitrage type of situation with Yahoo, Alibaba, Yahoo Japan and Cash and whatnot?

    Thanks again. Great Blog.